Lambers CPA review business envoirnment and concepts

Chapter Three Microeconomics with Strategy Emphasis Market Influences on Business Strategies, Including Selling, Supply Chain, and Customer Management Strategies An understanding of m

CPA REVIEW

by Vincent W Lambers, MBA, CPA, Donald T Hanson, MBA, CPA,

4 Business Environment

& Concepts

4 Business Environment

& Concepts

CPA REVIEW

by Vincent W Lambers, MBA, CPA and Richard Delgaudio, MBA, CPA.

3 Auditing &

Attestation

3 Auditing &

Attestation

CPA REVIEW

by Joseph R Lanciano, CPA, Michael F Farrell, J.D and Arthur E Reed, MBA, MST, CPA,

Paul Debole, J.D

2 Regulation

2 Regulation

CPA REVIEW

by Vincent W Lambers, MBA, CPA, Donald T Hanson, MBA, CPA, William A Grubbs, MBA, CPA

1 Financial Accounting and

Reporting

1 Financial Accounting and

Reporting

Published by 

Copyright © 2012 by LearnForce Partners, LLC

All rights reserved No part of this publication may be reproduced in any form without the written permission of the publisher

ACKNOWLEDGMENTS

It would be impossible to write a CPA examination preparation book of any kind without the assistance of the American Institute of Certified Public Accountants, and their various operating divisions, in granting permission to use various materials We respectfully acknowledge and thank those persons in the American Institute who promptly answered our inquiries

We also acknowledge the following sources, with our thanks for their assistance:

Material from the Certified Management Accountant Examinations, Copyright ©

1988 through 1996 by the Institute of Certified Management Accountants is reprinted and/or adapted with permission

Solutions to the CMA examination questions reprinted with the permission of Multimedia Management Training, Inc

Questions from Investment Planning: Multiple Choice Questions Workbook, Lesson

2, Keir Educational Resources, Revised February 2003, reproduced with permission

of Keir Educational Resources

Chapter Subjects of Volume 4 — BUSINESS ENVIRONMENT AND CONCEPTS

Chapter One CORPORATE GOVERNANCE

Chapter Two PROCESS AND PROJECT MANAGEMENT

Chapter Three MICROECONOMICS WITH STRATEGY EMPHASIS

Chapter Four BUSINESS CYCLES Chapter Five ECONOMIC MEASURES Chapter Six FOREIGN EXCHANGE Chapter Seven FINANCIAL MODELING Chapter Eight STRATEGIES FOR SHORT- AND LONG-TERM FINANCING OPTIONS

Chapter Nine FINANCIAL STATEMENT IMPLICATIONS OF LIQUID ASSET MANAGEMENT

Chapter Ten INFORMATION TECHNOLOGY IMPLICATIONS IN THE BUSINESS ENVIRONMENT

Chapter Eleven COST ACCOUNTING: ACTUAL COST, JOB ORDER AND PROCESS

Chapter Twelve COST ACCOUNTING: JOINT PRODUCTS AND STANDARD COSTS

Chapter Thirteen MANAGERIAL ANALYSIS AND CONTROL

Chapter Fourteen MANAGERIAL PLANNING AND CONTROL

Material from Uniform CPA Examination Questions and Unofficial Answers, copyright © 1977 through 2010 by the American Institute

of Certified Public Accountants, Inc., is reprinted (or adapted) with permission

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1 The Role of the Board of Directors:

a The Board of Directors is an elected or assigned group of individuals who jointly monitor the activities of a company or entity

b The Board’s activities are steered by authorities and responsibilities given by another

authority (stockholders)

2 8 Basic Board of Director Duties With Regard to Financial Reporting:

a Review and monitor corporate procedures (operating through strategic) including

financial plans

b Establish policies of ethical conduct and oversee adherence to those policies (“Tone at the Top”) These policies can also be enhanced by management

c Understand the corporate risk profile and monitor risk management programs

d Comprehend the organization’s financial statements and oversee adequacy of all internal controls including financial controls

e Monitor chief executive officer (CEO) compensation and goal setting

f Oversee the process of efficient and effective financial reporting to the stockholders

g Establish senior management succession

h Review the functioning of the Board of Directors and committees to determine candidates for succession

3 Securities and Exchange Commission (SEC) The Security and Exchange Commission gave

the United States Stock Exchange Boards (NYSE, AMEX) and NASDAQ the authority to:

a Mandate that all members of the Board of Directors be independent Independence in this instance means that “no material direct or indirect relationships within an

organization, including its Board members, with customers, vendors, immediate family who are customers or vendors Stockholdings are considered independent of

management The SEC requires a five-year cooling off period from any relationship mentioned above before a board member can be considered independent

b Expand the Board of Director’s and associated committee’s authority This includes audit committees

4 Audit Committee An Audit Committee is composed of outside directors that have the power to:

a Appoint, compensate and supervise external auditors

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b Monitor the independence of its own committee members

c Confidentially monitor the accounting and internal control process

d Hire outside advisors such as legal counsel and other topical experts

An Audit Committee must be no smaller than 3 members and be independent of the

organization The Audit Committee must be financially literate, one member must accounting/financial experience (CPA,CMA) The Audit Committee must have the ability to create a charter specifying its policies, tasks and authority It must also be able to oversee the preparation of the financial statements from an internal (employees) and external (auditors) perspective

In addition to the above, an Audit Committee must:

a Prepare an audit process report annually which will be available to the Board of Directors

b Handle and rectify complaints on accounting, internal control and audit affairs

c Receive reports from external auditors

d Monitor disagreements between auditors and management

e Monitor quarterly and annual reports

5 Internal Control is the monitoring and actions of an organization created to ensure that

information in reports is recorded, processed, summarized and communicated within a specified time period These procedures give credence to the fact that financial statements adhere to a reporting framework (Generally Accepted Accounting Principles/International Financial

Reporting Standards)

6 Committee of Sponsoring Organizations (COSO) consists of the AICPA, FEI, IMA, IIA and

AAA appointees who established a framework of internal control that was issued in 1992 This is

the framework of internal control for public companies in the United States

Other frameworks include the Control Objectives for Information and Related Technology (COBIT) and Auditing Standard 5 COBIT is administered by the Information System Audit

and Control Association (ISACA), whereas Auditing Standard 5 is issued by the Public Company Accounting Oversight Board (PCAOB)

In 2004 COSO updated the framework to incorporate Enterprise Risk Management (ERM) that

enhanced the internal control framework it originally issued Both frameworks are now

incorporated into ERM and are in use today

7 Enterprise Risk Management (ERM) uses strategic and operational procedures to identify,

assess, manage and control possible occurrences or circumstances in order to give reasonable assurance to the Board of Directors, Audit Committee, and management regarding the

accomplishing of the organization’s objectives

Enterprise Risk Management entails:

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a Coordinating risk appetite and strategy How much risk is an organization willing to endure in order to attain its strategic goals

b Supporting risk response decisions to either avoid, reduce, share or accept risk

c Decreasing operational unawareness and associated costs, losses or unexpected

occurrences

d Determining and mitigating organization-wide risks that will enhance and encourage effective and integrated responses to risk

e Seeking proactive opportunities in determining risk occurrences

f Placing capital where it would be most effective in mitigating risk

The COSO Model is a three dimensional perspective when viewing ERM The four objectives

are strategic (such as a mission statement, long term goals), operations (short term efficient and effective use of resources), reporting (reliability of financial information) and compliance (legal and statutory matters

It is important to know the 8 components of Enterprise Risk Management

a Internal Environment is the tone of an organization Views on risk, integrity and ethics

should be determined by senior management and monitored by the board of directors

b Objective Setting is the creation of accomplishment tasks that are consistent with an

organization’s mission statement and risk appetite

c Event Identification is defined as internal and external activities affecting tasks toward

achieving organizational objectives that must be identified and determined to be a risk or opportunity These events must be communicated to management

d Risk Assessment is the scrutiny of risk to determine potential occurrence and effect of risk

on the organization It also entails determining how to manage risk whether it be inherent or residual

e Risk Response is used to avoid, reduce, share or accept risk This must be performed by

management assuming that management is aware of both organizational risk tolerance (risk

in individual tasks) and risk appetite (the overall organizational risk management is willing to endure)

f Control Activities are the rules and tasks created and put into place to enable risk responses

to occur

g Information and Communication: Appropriate data is gathered and disseminated in a

timely manner and medium in order for those using it to accomplish tasks This is especially important to management in managing change in an organization The lines of

communication can be top-down, bottom-up and across functions or divisions

h Monitoring either by management and/or inside or outside evaluators such as auditors and

regulatory agencies

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Summary

The framework does not work in the same manner in every organization due to unique

effectiveness and limitations scenarios The chart below summarizes the basic roles of the

different groups in an organization

Board of Directors/Audit Committee Monitoring oversight entity-wide

Executive Management Monitoring oversight with delegation duties

Operations Management Executing duties to mitigate risk

Auditors Advisory role in ongoing risk reduction

activities Chief Risk Officer Identification of risk

Chapter  One 

Multiple  Choice Questions  

1 Which of the following is NOT a board of

directors’ responsibility or requirement?

a more than one member of the board of

directors should be a financial expert

b monitoring the work of the external

2 The time that must pass in order for a

member of the board directors to be

considered independent from a company

where that member was once an employee

according to the National Association of

Securities Dealers Automated Quotation

a the chief operating officer

b the chief executive officer

c the board of directors

d the chief financial officer

4 A CPA firm performing an audit under

Section 404 of the Sarbanes-Oxley Act is

required to communicate all of the following

matters to the board of directors EXCEPT

a the subjective aspect of management’s

significant accounting practices

b disagreements with management

c all material misstatements, corrected or

a the chief operating officer’s salary

b the chief information officer’s stock options received

c the chief financial officer’s car parking allowance in a private parking lot

d the chief risk officer’s bond conversion options

6 What is best definition of a company’s risk tolerance or its risk appetite?

a risk tolerance is the sum of all of the risks that a company is willing to endure in order

to achieve its goals

b risk appetite is the product of all of the risk tolerances in a company’s business processes

c risk tolerance is the amount of inherent risk experienced by a company at any time

d risk appetite is the remaining risk after a company implements its internal controls

7 All of the following are external monitors

8 The difference in the fine assessed by the

Securities and Exchange Commission

between a certification and a willful

certification on and by a chief executive or

chief financial officer that does not adhere to

the requirements of the Sarbanes-Oxley Act

9 The most efficient way for a board of

directors to audit itself is through the use of

a another board of directors’ assessment

b the audit committee

c questionnaires

d external auditor inquiry

10 The audit committee should have in

place a mechanism to handle the reports and

concerns of all of the following groups

11 Which of the following is NOT one of

the five original components of internal

control regarded by the Committee of

Sponsoring Organizations of the Treadway

12 Which of the following is LEAST

effective in monitoring the inventory level

of a company?

a perpetual inventory system

b economic order quantity formulas

c material requirements planning

d just-in-time inventory system

13 What is the BEST example of an escalation trigger department that would identify a risk event?

a board of directors

b help desk

c quality inspection team

d environmental disaster crew

14 Enterprise Risk Management can provide for all of the following EXCEPT

a assurance against encountering a black swan event

b improving methods of investing risk capital

c coordinating efforts against simultaneous risks

d encourages control of opportunities

15 Accounts receivable write-off is BEST handled by which department?

d human resource policies

17 Which of the following statements is FALSE?

a operating management has the responsibility to carry out risk mitigation

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b chief risk officers measure risk on an

ongoing basis

c internal auditors act as advisors regarding

risk

d chief executive officers have the equal

responsibility of risk oversight along with

the board of directors

18 Limitations to Enterprise Risk

Management includes all of the following

EXCEPT

a subjective decisions regarding risk

b inappropriate analytical assessment of risk

appetite

c management override of controls

d collusion among employees

19 Which of the following is NOT part of

managing change in a company?

a an effective method to receive requests for

process improvements

b an effective method to scrutinize

proposed enhancements to processes

c an effective method to quickly implement

change

d an effective method to test the effects of

change

20 A method that is NOT effective in

responding to inherent risk is

a avoidance

b reduction

c sharing

d acceptance

21 The LEAST effective method of

executive compensation to dovetail

management and stockholder objectives is

a a bonus given after five years for

performance

b a small fixed salary and a larger commission package based upon economic value added

a chooses the external auditors

b implements governance guidelines

c determines employee salaries

d monitors chief executive officer succession

23 The greatest conflict among those externally monitoring the activities of a company listed below is:

a company attorneys who provide inside legal counsel

b investment analysts who rate the company stock and are employed by an investment bank

c creditors who monitor the company’s financial ratios for compliance to agreements

d a stockholder who has a minor role in the possible takeover a company

24 Technology would play the SMALLEST role in which of the following COSO

28 Which of the following is LEAST likely

to be a role of an external auditor with regard to corporate governance?

25 Losses on long-lived assets should be

mitigated by

a informing the board of directors regarding corporate governance

a co-insurance for the book value of the

asset b ensuring compliance with risk mitigation

procedures

b assessments of risk by the board of

directors c assessing areas of risk during the course

of an audit

c insurance carried on them based upon

independent valuation by an appraiser d follow-up on recommendations regarding

risk in management letter communication

d a predetermined amount at the time of the

purchase of the long-lived asset

29 Change communication would be most useful in which of the following situations?

26 A separate compliance department of a

company in a heavily regulated industry is

more likely to a informing employees regarding

reassignment of certain personnel

a respond quicker to outside threats to an

individual company within the industry

b informing employees regarding mandatory attendance of a continuing professional education event

b strengthen operating controls over the

long-lived assets of the company c informing employees of a remote attempt

of a takeover by another company

c maintain greater independence from the

company d informing employees of a change in a

minor process affecting one percent of the company

d have a more unbiased awareness of

company risk

27 Which of the following groups has the

LEAST amount of responsibility for

d internal auditors c involvement of affected employees in

creating new change procedures

d including the monitoring process of the change in an external audit

Chapter One

Answers to Multiple Choice Questions

1 A One financial expert is appropriate according to the Sarbanes-Oxley Act The other choices are a board of directors’ responsibility

2 C NASDAQ requires that three years elapse between prior company employment and

appointment to the board of directors by an individual The New York Stock Exchange requires that five years elapse between these two circumstances

3 B A chief audit executive should report administratively to the chief executive officer and functionally to the board of directors

4 D It may inappropriate and it is not a Sarbanes-Oxley Act requirement for external auditors to discuss fees of other firm’s accountants with the board of directors unless instructed to do so by the board of directors

5 C All compensation of the chief financial officer must be disclosed to the Securities and Exchange Commission, but not the compensation of the COO, CIO or CRO

6 B Risk tolerance related to individual business processes range of risk allowed Multiplying all of the risks of the business processes together equals the risk appetite for a company

7 A The board of directors are an internal monitor of a company, the other choices are all

10 A Stockholders ultimately vote on board members positions and are not part of the

governance process that is recommended in the Sarbanes-Oxley Act

11 D Event identification along with risk assessment and risk response were added in 2004 to the COSO framework in establishing Enterprise Risk Management parameters for a company

12 C Material requirements planning monitors the amount of periodic production required based upon past trends of customer ordering to determine future customer needs Inventory is better monitored using a perpetual system involving economic order quantities based upon analytical information or a just-in-time process driven by customer demand that allows for lean or no inventories

1S 1 

13 B The quickest and most accurate response to a risk event would be an information

technology help desk member who would route a request to the appropriate personnel The other choices would involve a larger lapse of time from end user or event to mitigation of risk

14 A No one can assure the complete avoidance of an unexpected or remote event from

occurring

15 A Someone outside of the sales/accounts receivable/sales returns function should be

responsible for the approval or execution of writing off uncollectible accounts

16 C Business processes themselves are not part of a control environment They need to be monitored and organized in an appropriate manner The other choices are all part of the control environment according to COSO

17 D The board of directors has the ultimate responsibility for ERM that is then delegated to executive management

18 B Inappropriate assessment of risk appetite is not a limitation to ERM as much as it is the analytical, objective judgment involved by individuals in determining it as a product of risk tolerances and is not basic control within ERM All of the other choices are specific detailed or inherent limitations to mitigating risk

19 C Efficiency is not always appropriate in managing change Time taken to explain and implement change can go a long way in mitigating resistance to it This may be an appropriate slowing of the process for a more long-lasting satisfaction with the change among those affected

20 A Avoiding risk does not eliminate and may not even mitigate it, thus it the least effective method for handling it

21 C Stock options have the most short-term horizon of the four choice listed Economic value added to a company determines economic profit of a company that includes a cost of capital in sustaining company growth along with accounting profit

22 D Monitoring chief executive officer succession is a specific duty of a board of director’s nominating committee That committee does not involve itself with other responsibilities carried out by the management

23 B Investment analysts may have a conflict of interest if they are rating securities of a

company that happens to be soliciting the investment bank employer of the analysts for

underwriting their securities

24 A The control environment relates to individual opinions, values and attitudes toward a company’s control environment that would involve written policies and procedures and not necessarily technology for their creation

1S 2 

25 C Independent assessment represents the best choice to determine the long-lived asset value

to mitigate the risk of inadequate insurance for the asset

26 D Appropriate separation from management by the compliance department would tend to alleviate some or most of a company bias imposed or influenced by the control environment It

is not appropriate for the compliance department to be completely separated from the company whose compliance is being monitored

27 D Internal auditors may advise regarding corporate governance procedures but are not

responsible for its creation or implementation All of the other groups in the answer choices are responsible

28 B An external auditor can never assure complete compliance with risk mitigation procedures

29 A The breakup of work groups may sometimes be traumatic in the short-term and cause resistance to that particular change by affected employees Communication well in advance of the change in a clear, appropriate manner may ease some or even most of the resistance to this potential sensitive matter

30 C Involving employees affected by a change to become change agents themselves best enhances the way change can be communicated in a company both formally and informally among employees

1S 3 

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Chapter 2

Process and Project Management

This chapter focuses on the process and project management sections in the Business Environment &

Concepts section of the CPA Exam The first part of the chapter will focus on Process Management, whereas the second part will focus on the Project Management area There are quite a few lists in this

chapter that need to be learned and memorized

Process Management can be defined as “an all encompassing approach to obtain continuous fitness of product or service improvement in and through the actions performed in an organization” In other words

it is the coordination of organizational activity in harnessing improvement and streamlining it to achieve greater profitability

There are many approaches to process management that can be taken Initially the overall benefits of process management are decreasing customer product returns, decreasing warranty provisions made, decreasing amounts of capital tied to inventory, increasing perception of product value, decreasing

processing costs and increasing reliance in process schedules

1 Total Quality Management (TQM)

Total Quality Management (TQM) uses quantitative methods to constantly enhance organizational

processes It also involves coordination of managers and employees goals to those of the organization In addition, TQM involves strategic planning due to the significant number of quality costs that compose product pricing and the lengthy implementation process

There are four objectives to TQM:

a Top notch consistent product quality

b Instant and consistent reaction to customer desires

c More adaptability in maintaining customers varying requirement

d Lower costs through enhancements and removing non-value added work

Faulty processes are usually the reason for poor quality An organization may require a paradigm shift in

corporate style in order to improve faulty processes Proactive management, corporate-wide training, and enabling all levels of employees to make decisions on product quality are ways to improve faulty

processes Preventive and not corrective action is encouraged Improvement teams can be used to help focus on problem awareness

There are five key required aspects of TQM These are:

a TQM should offer acute focus on customer satisfaction as job retention depends on it

b Focus on internal and external customers (purchasing, receiving, assembly, shipping, sales) where each department if a customer to the succeeding department

c Analyzing critical success factors (an organization can only improve if it knows what and how to measure)

d Constant improvement of finished goods and services

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e Reliance on co-workers and departments across the organization

An organization’s ability to measure its performance is an essential factor for improvement

Measurement aspects include the Deming cycle (plan-do-check-act) This cycle measures how processes

are thought of, carried out, monitored and improved upon Another familiar measurement aspect is

benchmarking, which compares an organization’s processes against the best in the class at a particular

process

Other measurement aspects include:

a Statistical Control which uses charts to monitor defects

b The Taguchi quality loss function determines the financial loss due to quality defects in an

organization’s products and services

c A Pareto Diagram shows that just a few deficient processes create the majority of losses

d The Ishikawa (cause and effect diagram) shows the cause of a certain event over a time period

and isolates reasons for defects

Measurable quality costs can be segregated into two categories in an organization’s quality reports These

are conformance costs and nonconformance costs Conformance costs are those costs that occur before

a product is shipped or a service is provided Examples of these costs (preventative costs) can be training, evaluation and vendor costs Appraisal costs such as inspections, testing by employees or departments are also examples of conformance costs

Nonconformance costs are those costs that occur after a process is completed internally, or after a

product or service is provided to the customer Examples of these costs are internal failure costs such as scrap or retooling of machines External failure costs also fall into this category, examples being

warranties, product returns, lawsuit and faulty product costs

2 Shared Services

An organization may decide to group non-required and support staff into one separate department,

division or company to enhance already existing services This streamlining action of shared services

can improve consistency, core process concentration and tracking of common costs

There can be some pitfalls to utilizing shared services These can include:

a A narrow focus on needs in the short term to spend needlessly

b Lack of specialized knowledge to affect proper deployed shared sources

c Faulty or too rapid of implementation A slower implementation is more effective

d Administrative and financial failure due to lack of coordination with employees of different skills sets and the inability to set pricing for the services they provide

e Lost internal control during the change process and inherent risks during the process should be monitored and mitigated immediately

2 3  

3 Outsourcing

Outsourcing is acquiring a product or service instead of producing it In today’s business world some of

the more common functions to be outsourced include information technology, human resources, customer service and transaction processing An organization may gain some benefits by outsourcing These include:

a Gaining outside knowledge and access to new technologies

b Acquiring less expensive services than those produced in-house

c Avoiding inventory obsolescence

d Minimizing administrative overhead

e Enhancing quality in products or services

Outsourcing can also expose an organization to some risks Risks include:

a Excess costs involved in specific knowledge

b Loss of human expertise

c Internal control loss of quality

d Loss of knowledge exclusivity

e Strategic planning suffers due to reliance on outside expertise

f Production rigidity may be experienced on supply chain loss

4 Foreign Operations

Off-shore (Foreign) operations offer the allure of cost savings as costs of doing business in the United

States can appear to be prohibitive Other gains that can be had by off-shore operations are:

a Quality of service can be maintained or improved

b New Sources of expertise acquired that may not be available domestically

c The off-shore operation may turn into a strategic business unit for the foreign operation

d Can offer a refocus on core domestic business operations

e New processes are implemented quicker in a new operation

f Drains on capital decreased if core business is profitable and off-shoring is done inexpensively There are many different business and control problems associated with off-shore operations Conditions such as language and cultural differences can have a substantial effect on the success (or failure) of off-shore operations Problems include:

a The savings never materialize

b Exorbitant training costs and language barriers

c Unproductive staff

d Inability to acquire productive staff due to competition abroad in particular services

e Focus on tasks may shift from a foreign worker’s standpoint

f Cultural differences in work habits

g Initiative to be proactive might not occur in order not to be disrespectful of the corporate office

h Plateaued employees become unmotivated with mundane tasks

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5 Implementing Total Quality Management

The implementation of TQM does not occur instantly It involves careful consideration and patience to succeed in a procedural insertion There are basic steps and organization should take when instituting TQM

The year one step is to “prepare and plan” Organizations must develop a quality oversight committee

and implementation team This implementation team and their techniques must be approved by the Board

of Directors and CEO for the TQM to work properly Year one steps also include instilling training programs on TQM techniques in order to increase awareness of quality, determine common data

recognition regarding quality techniques, and develop appropriate goals and minimum standards These training programs should occur at all organization levels

In addition, year one activities include conducting quality audits These audits will review and compare organizational steps against those of best practice organizations The first year audits will also determine organizational assets and liabilities regarding quality Gap analysis should also be conducted to pinpoint the exact areas where quality enhancements are needed in an organization’s process The organization should then develop a plan to improve quality in the short and long term The short term plan should use smaller implementation projects and gradually build to larger ones in the long term

Year two steps are to teach and deploy employee training sessions conducted by qualified instructors in

TQM techniques Quality teams should also be developed These teams should have a member from each proper area of the organization participate in order to monitor the results of improvements

throughout the organization These members become “owners” of the quality process Year two steps

also include creating a gauging system of performance that would revamp the accounting system to

communicate pinpoint accuracies in appropriate tasks that may entail many general ledger accounts

In year three the steps will examine, make decisions and change the TQM program These steps include:

a Compensating and reinforcing TQM enhanced improvement and employee behavior (morale boosting)

b Involve vendor participation to ensure reasonable expectations of quality, timeliness of product delivery, commitments as colleagues of TQM, and consistency of products

c Update TQM techniques on regular basis

6 Business Process Engineering (BPR)

Business Process Engineering (BPR) is the intricate scrutiny and complete makeover of business and

production activities in an organization It is done to increase quality and cut costs Key considerations

of BPR are:

a Asking why we are doing this? Is there a reason we are performing this task this way?

b Creating new thoughts regarding work patterns

c Upheaval of processes needed

d Linking all process together in a “cause and effect” relationship

2 5  

BPR requires that some steps be taken in order to support it First, emphasis should be placed on the process and not organization in review of the workflow Second, BPR supports paradigm shifts and large changes over time versus a few incremental changes in work flow processes Previous thought processes regarding workflow are eliminated Technology may be used to drive the change in thought process

7 Management Schools of Thought

There are several management “schools of thought” that may be asked on the CPA Exam One of these

thoughts is the Just-In-Time Inventory System that has the following characteristics:

a Demand-pull in nature Customer orders trigger activity

b Work teams are multiskilled across manufacturing functions to get the work accomplished

c Inventory is reduced or eliminated as it is worked on as soon as it arrives from a vendor This is also known as lean production, no waste or inventory is allowed

d Vendors must adhere to on-time quality product delivery

e Operates on “Kanban” or ticket system to move inventory between workstations to attain a finished product

8 Process (Demand Flow)

Process (or demand flow) is the study of activities that combine to take a raw material and turn it into a

finished good There are value added steps throughout the process that should encompass effectiveness, efficiency and adaptability The process should address the following:

a Does the work involved improve the product?

b Does the output end up when and where a customer would want it?

c Does the product cost too much compared to other products?

d Is the workflow process adaptable to customer requirements should those requirements change?

9 Theory of Constraints (TOC)

Theory of Constraints (TOC) is based upon the premise that “time is money” It focuses on quickening

of the manufacturing process Time is measured in cycles and the main cycle is the time between receipt

of a customer purchase order to the shipment of that order Imbedded in the cycle are non-value added activities This subset of cycle time is called processing, or value added time The percentage of

processing time that encompasses the cycle time is called manufacturing cycle efficiency The

manufacturing cycle efficiency percentage should be monitored by management and should be as high as possible

In manufacturing processes TOC views all costs except raw materials as fixed costs The reason is that the processes can be delayed (bottlenecked) because of labor, overhead and machinery (not the raw material) The process of TOC Review involves these aspects:

a Determine constraints using a workflow diagram

b Decide which products should be manufactured given the constraints Those with the greatest throughput margin offer the greatest opportunities for future sales This margin is (Sales minus Raw Materials Costs) The costs are deemed supervariable

2 6  

c Optimize process flow through the constraint by determining a proper time amount for the process This is done while keeping the flow constant and identifying the steps in the process right up to the constraint

d Add labor, overhead or fixed assets to alleviate the constraint and improve cycle time

e Reengineer the workflow process if necessary for flexibility and cycle time improvement

f Can also work for overhead management and adopting activity based costing to properly allocate activity costs

10 Six Sigma

Six Sigma is a management technique to eradicate defects and minimize variations in a manufacturing

process It uses experts (sometimes call black belts) to keep improving the process using quantifiable measures such as increased income and decreased costs Six standard deviations from a man in a

population is where the term “Six Sigma” is derived It means that near 100% of product contains no defects

The goals and aspects used are quite similar to those of TQM and were inspired by William Edward Deming’s model of quality improvement Six Sigma has two main processes The first one enhances existing product and follows the following steps:

a Define a problem from a customer’s viewpoint

b Measure job flow tasks and gather data

c Analyze the data to discover problems in job flows

d Improve the process by experimenting with new process flows

e Control future work flows by creating control points in the new work flow patterns and monitor improvements

The second Six Sigma Process determines new work flow processes for a product This second Six Sigma process will:

a Define goals consistent with customer desire and international

b Measure steps and procedures that are essential to product quality, capability and risks

c Analyze different work flow patterns and decide on the ideal one

d Design the detail of the new work patterns and roll it out incrementally

e Verify the ideal design will work properly, prepare a trial run and deliver it to the new process owners

11 The International Standard Organization (ISO)

The International Standards Organization (ISO) developed areas of quality control standards that are

used throughout the world in many companies and provide common databases of knowledge for constant improvements by gauging efforts within organizations and steps to alleviate environmental issues The different ISO Series are:

a ISO 9000 Series covers quality management standards

b ISO 14000 Series covers management of environmental systems

2 7  

c ISO 25000 and 27000 relate to software and security quality in information systems

Part 2 Project Management

Project Management is a procedure to plan, organize, direct and control organizational assets in order

for goals to be accomplished within a specific time period and a specified monetary figure

Organizational assets include human capital, fixed assets, funding and time A project’s life expectancy encounters four phases These phases are:

a Contemplating a start of a project due to determine goals, scope, funding, management and participants

b Determine work quality specifications, milestones, finished product details and amount of work required

c Carry out the project as well as monitor, adjust and document it as necessary

d Finish the project; turn it in for evaluations and recommendations

The project management environment can be depicted by a triangle show below

The most important of these constraints is the quality of the items given to the organization at the end of the project The Project Management Environment includes as part of the three constraints:

a Monetary Budgets

b Time Budgets

c Work parameters to guard against “Scope Creep”, where non essential tasks are included in the actual performance of the project

d All of the constraints work either conversely or inversely with one another

1 Enterprise Resource Planning (ERP) is used to manage a project throughout all of an

organization’s departments This is the use of one database for all of the required information to complete the project (SAP, Oracle) Customizing ERP is a costly, cumbersome process and it may be easier to change certain business processes that to update ERP software

Scope & Quality 

Time Constraints  Monetary Constraints 

2 8  

2 Project Management techniques include Gantt charts that depicts starting and ending times of projects noted on a calendar Gantt charts show the interrelationships of tasks within a project Histograms are bar charts used to determine the number of instances for certain events

Network analysis determines the quickest route through a project by detailing each event

involving work steps within a project

3 Performance Evaluation Review Technique (PERT) is used when constructing a large asset

such as an airplane, skyscraper, etc Each project has a starting and ending point with milestones and accomplished tasks interspersed though the diagram Connecting lines between the

milestones depict time spent to accomplish a certain task By mapping out and measuring the time required to accomplish tasks, the longest time to complete a project can be determined This

is called the Critical Path

The critical path has no slack time on it, thus all of the tasks on the critical path cannot be

delayed, or the entire project is delayed PERT is also known as the critical path method since the concepts are intertwined Since there is no slack time on the critical path, if the time to complete

a project is shortened, the first place to “crash” the project are the tasks on the critical path The tasks that alleviate the greatest time constraints or are the least costly should be crashed first Using PERT (Critical Path Method) will also identify:

a Idle or slack time

b Where additional personnel are required

c The need for lead time to receive outside inventory or labor

d Tasks that can be completed simultaneously

PERT does not clearly depict relationships of one task to another as clearly as a Gantt Chart PERT uses a weighted average of time expected to perform each task One sixth of the weight is given each to the shortest possible and longest possible expected times to complete the tasks Two-thirds of the weight is given to the most suitable amount of time needed to complete a task Critical Path Method is helpful when times to complete tasks are previously known and incentive

is given to shorten times for future tasks

4 Other Models used in Project Management

There are other models that are used in Project Management Algorithms are used to determine shortest routes for scheduling in transportation situations This can be used to determine

movement of products by trucks or the flow of a product such as oil

5 Job Responsibilities for Project Personnel

A Steering Committee oversees the entire project They are specifically responsible for:

a Alleviating disputes between organization management and project members

b Making sure the project stays in budget

c Funding is made to the project in a timely manner

d Representing stakeholders in negotiations with management

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Stakeholders can be one person or an organization within or external to the project organization

The stakeholders have a financial interest in the success and completion of a project Managers, sponsors and team members can be stakeholders

Whereas sponsors provide monetary backing for the projects, managers actually lead the team

members of the project The manager’s primary goal is to manage people, deal with and resolve conflict within and between teams Managers do not need to be experts in every aspect of the project

Team members carry out the tasks required to complete the specific tasks of a project They

enter and leave the project as requested

Chapter Two

Multiple Choice Questions

1 Measurement of the quantitative sales plan versus

budgeted sales plan would fall under which critical

success factor in a balanced scorecard approach?

a financial performance

b customer satisfaction

c internal business processes

d innovation and learning

2 The acquisition of market share acquired during

the year would be measured under which of the

critical success factors in a balanced scorecard

3 Which of the following is NOT a weakness in the

balanced scorecard approach?

a overwhelming number of measures

b relying on perfecting qualitative measures

c short-term focus

d trying to improve all areas all the time

4 In a Just-In-Time production environment, which

of the following does NOT occur?

a vendor products are inspected at the vendor’s

process facility

b the number of orders placed increases

c reliance on electronic correspondence with the

vendor increases

d the production environment is organized based

upon specific functions

5 Companies that have implemented a Just-In-Time

production environment usually experience

a lower inventory turnover

b higher inventory carrying costs

c a decrease in the number of raw material vendors

d production workers with specialized and not

diversified skills

6 The first step of the lean manufacturing process is

to

a identify steps in a value stream

b let customers determine what value means to them

c specify value and value streams in an internal process

d process a product efficiently and effectively

7 Lean manufacturing works best when

a the emphasis to use and perfect it is top-down driven

b seen exclusively as a process to reduce costs

c return on investment analysis is emphasized to production workers

d consultants are used to train others to see inefficiencies in a business process

8 The process considered most downstream of the following is

11 Which of the following is NOT associated with

a total quality management emphasis in business

processes?

a satisfaction of internal suppliers

b gap analysis to determine defects in the

12 The Lambda Company had the following costs

in the year just ended:

- Quality training costs $125,000

- Maintenance costs of finished goods prior to

c shipping costs for customer returns

d cost of replacing machinery with state of the art

components

14 In an existing process, which of the following

steps is required immediately following the

measurement of that process when trying to

improve it using the Six Sigma method?

a improve the process

b analyze the process

c control the process

d design another process

15 Which of the following is NOT a step in implementing a Six Sigma process?

a determine best in process measurements

b reward enhancements

c bestow ownership of the process

d develop a criteria requiring change

16 Given the following information for Gamma Company:

Sales: $1,000,000; Direct materials: $450,000; Direct labor $250,000; Indirect materials: $50,000; Indirect labor and other overhead: $75,000 What is the throughput contribution margin?

(The following information is required to answer

questions 19-21)

The Furniture Store wishes to open a new store in a

different part of the country It has the following

steps with a required order to complete them:

Activity Completion

Time in Weeks

Immediate Activity Predecessors

Stucco the store

exterior

1 Design Store

exterior Hire and train

staff

3 Develop staff

requirements Install Neon

signs

2 Stucco the store

exterior Obtain

19 What is the length of the critical path?

a 8 weeks

b 9 weeks

c 10 weeks

d 11 weeks

20 The store must open in seven weeks If each

activity costs $500 per week to crash those activities

longer in duration than one week, and one week is

the minimum time that each activity can take to

complete, what is the total cost of crashing in order

for the store to open on time?

a order inventory and stock the showroom

b stucco the store exterior

c develop staff requirements

d install neon signs

22 If an activity has a pessimistic time for completion of thirteen weeks, a most likely time for completion of ten weeks and an optimistic time for completion of eight weeks, what is the probable estimate for completing the activity?

a 9.7 weeks

b 10.7 weeks

c 10.5 weeks

d 10.2 weeks

23 What is the biggest benefit of a Gantt chart?

a the inclusion of the time required to complete a project

b the inclusion of the capability to provide a project status at any given time

c the inclusion of the number of tasks needed to complete a project

d the inclusion of depicting the time interrelationships of different tasks within a project

24 Which project management tool would represent the number of times an event occurs during a project?

25 The critical path method is most useful when

a the tasks to complete the project can be cost

precisely

b the tasks to complete the project are susceptible

to crashing

c the time required to complete tasks is known

d the slack time within a project can pinpointed to a

specific time frame

26 Algorithms are best used to solve which of the

following project types?

a staffing

b transportation

c queuing

d time reduction

27 Which of the following groups of people

represent project stakeholders in negotiations with

management?

a steering committee

b sponsors

c project managers

d project team members

28 A project life expectancy has all of the following phases EXCEPT

a determining project funding

b determining finished product specifications

c contemplating the finish of a project

d providing recommendations

29 The specification of a project must be detailed at its outset as mitigation to

a under budgeting

b the inability to find stakeholders

c the sustainability of project team motivation

d scope creep in a project

30 The final step of a project effectiveness is concerned with

a providing recommendations

b delivering a final product

c presenting a formal walkthrough of the work performed

d submitting a final billing for all project costs

2Q-4

Chapter Two

Answers to Multiple Choice Questions

1 C The comparison of the actual sales performance against the sales budget is an internal business

performance and not a financial performance or customer satisfaction exercise

2 A New market share is garnered through new and improved techniques in sales, advertising and/or product innovations

3 C Balanced scorecard focuses on long and not short-term goals, thus a short-term perspective is not a

9 B Product design is where the product costs get locked-in, and cannot be changed significantly afterward

10 D The sales department that is the closest department to the source of inventory demand, the customers is responsible for maintaining proper inventory levels in a demand flow management system

11 B Gap analysis measures the difference between a company’s processes and best in class processes and not gaps within the processes that internally determined

12 C Maintenance costs prior to shipping occurs after production but prior to shipment and is an internal failure cost The cost to reship parts is an external failure cost Both of these costs are non-conformance costs The rest of the costs involve preventive or concurrent controls in a production process and are conformance costs The four of them total $320,000

13 B The inability to keep auxiliary material saleable in the production process is an internal matter, provided the products are not returned from a customer following shipment

14 B Once measurement takes place, an analysis is conducted, followed by improvement and control Design

is not part of the Six Sigma process

15 A Change in a Six Sigma process is internally driven from a need determined by a change champion and does not necessarily involve mirroring best in class processes

16 A Sales minus direct materials cost equals $550,000 All of the other costs are considered in a Theory of Constraints environment to be fixed costs

2S-1

17 B A series of events, like a chain or a rope lead up to and include a bottleneck The pace of the process is called a drum and the amount of material needed to keep the process moving uninterrupted is called the buffer

18 C The entire process from the time an order is received until the time it is shipped takes ten days and within the process three days are spent for non-value added activity such as inspection and waiting for product to be shipped 7 divided by 10 is 7, that measures the amount of value-added production days are included in the total production process

19 D The process to design the store exterior, determine furniture designs, order inventory/stock the showroom and obtain financing to open the store takes 11 weeks, the longest to complete, and it is the critical path The process to design the store exterior, develop staff requirements, hire staff and obtain financing to open the store takes 10 weeks The process to design the store exterior, stucco the store exterior, install neon signs and obtain financing to open the store takes 9 weeks

20 C The cost for each of these three paths to be no longer than seven weeks through crashing is $4,500 The critical path would cost $2,000 for its crashing, the 10 week process would cost $1,500 and the nine week process would cost $1,000 (11-7=4, 10-7=3 and 9-7=2 Four plus three plus two equals 9 X $500 = $4,500.)

21 A Activities on the critical path should be crashed first, so ordering inventory/stock the showroom is the task to crash first given the answer choices

22 D The formula for the probable estimate to complete a task is sixth for the pessimistic time and sixth for the optimistic time The other four-sixths are given to the most likely time for task completion Add the six numbers up and divide the total by six Thirteen plus eight plus ten plus ten plus ten plus ten equals 61 That number divided by six rounds to the nearest tenth to 6.2

one-23 D Showing the time relationships among tasks within a project is an advantage to using a Gantt chart

24 A Frequency distributions shown from a historical perspective are best displayed in a histogram

25 C If a history is known on the time required to complete tasks in a current project that need to recur, a critical path can be more readily determined Performance Evaluation Review Technique diagrams are useful when there is no prior experience in the tasks required for completing a project

26 B Algorithms along with Boolean algebra tableaus are used to solve complex transportation problems along many destinations and distribution routes

27 A The steering committee is tasked with representing stakeholders in a project when negotiating benefits and costs with management Sponsors fund a project, but are not required to give representation to

30 A It is important to deliver a final product of a project or documentation regarding it, however,

recommendations to improve, implement, discontinue aspects relating to a project will help ensure a more lasting benefit to sponsors, stakeholders and management

2S-2

Chapter Three

Microeconomics with Strategy Emphasis

Market Influences on Business Strategies, Including Selling, Supply Chain,

and Customer Management Strategies

An understanding of micro-economics (the economics of the firm) starts with an understanding of the demand and supply curves and their intersection to determine the equilibrium price Let us review by examining a family’s demand curve for a commodity product such as milk in a regional marketing area such as New York City The graph below illustrates the demand curve

Demand Curve for Milk in New York City

The demand curve in graph A, above is illustrated by the line that is downward sloping to the right (D) The demand curve is downward sloping because of the law of diminishing marginal utility The law of diminishing marginal utility recognizes that the total satisfaction derived from the consumption of milk (or any good) will initially increase as more of the good is consumed and then total satisfaction will start to diminish The diminishing total satisfaction is reflected in the demand curve in that as the quantity per month increases, the consumer will be willing

to pay less for the next additional unit of the good The consumer might be willing to pay $3.50 per gallon for 8 gallons of milk per month, but would only be willing to purchase the ninth gallon of milk per month at some price less than $3.50 per gallon

From a strategic viewpoint, businesses seek to shift the demand curve to the right in order to sell a larger quantity at the same price or the same quantity at a higher price The various ways that a demand curve might shift to the right are the following:

1 Increase in the number of consumers

2 A change in tastes in favor of the good

3 Increase in the price of substitutes

4 An increase in the income of consumers

3-1

A shift in the demand curve should be contrasted with a change in quantity demanded on the same demand

curve A shift in the demand curve to the right signals that at each price point the consumer is willing to buy a larger quantity of the good On the other hand, a change in quantity demanded refers to a change in

demand on a particular demand curve A change in quantity demanded may be illustrated by reference to graph A Given the demand curve in graph A, a change in price from $3.50 per gallon to $3.00 per gallon will result in an increase in quantity demanded from 8 gallons per month to 10 gallons per month Thus, the term “change in quantity demanded” does not refer to a situation in which the demand curve has shifted Graph B below illustrates the shift in the demand curve from D to D1

Demand Curve for Milk in New York City

When you contrast demand curve D with demand curve D1 it is clear that for all price points the quantity demanded

is greater for demand curve D1 than it is for demand curve D That demand curve shift to the right could have been caused by any of the four causes mentioned earlier

The slope of the demand curve is of particular importance from a strategic perspective Demand curves tend to be either elastic or inelastic An elastic demand curve suggests that a small percentage change in price will result in a

larger percentage change in quantity demanded Using the demand curve in graph A, we can calculate the price

elasticity of demand for the situation in which the price declines from $3.50 per unit to $3.00 per unit Graph A

shows that the quantity of 8 gallons is associated with the $3.50 per gallon price and the quantity of 10 gallons is associated with the $3.00 price The coefficient of the price elasticity of demand for that portion of the demand curve is calculated using the following equation:

Percentage change in quantity / Percentage change in price The decline in price from $3.50 to $3.00 results in a $.50 change in price That represents the following percentage change in price:

$.50 / Average of $3.50 and $3.00 =

3-2

The increase in quantity from 8 gallons (associated with the $3.50 price) to 10 gallons (associated with the $3.00 price) represents the following percentage change in quantity demanded:

2 gallon change / Average of 8 gallons and 10 gallons =

2 gallons / 9 gallons = 22.22%

Therefore the price elasticity of demand is

22.2% change in quantity / 15.38% change in price = 1.44 Therefore the coefficient of the price elasticity of demand for that price change is 1.44 A coefficient greater than one suggests an elastic demand curve and a coefficient less than one suggests an inelastic demand curve

It is important to remember that the equation for calculating the coefficient of the price elasticity of demand has the Quantity on the top and the Price on the bottom To help you remember, think of a man that has his tie tied too tightly It is so tight that his tongue is hanging out as in Q for quantity The P (price) represents the tie around his neck

Inelastic demand is represented by a coefficient of price elasticity of demand that is less than 1 In such a situation the demand curve would tend to be more vertical than the one shown in graph A The demand curve for coffee would likely be more vertical than the demand curve for milk given that there is more of a tendency for the caffeine

in coffee to be slightly addictive The inelastic demand curve suggests that a large percentage change in price will result in a relatively small percentage change in quantity demanded

The difference between elastic and inelastic demand may also be examined in terms of the total revenue before and after a price change In the example in which the price changed from $3.50 to $3.00, the quantity changed from 8 gallons to 10 gallons The revenue associated with the $3.50 price was $28 ($3.50 X 8 gallons) and the revenue associated with the $3.00 price was $30 ($3.00 X 10 gallons) Thus, for this relatively elastic demand curve (in the interval of $3.50 to $3.00 per gallon) illustrated in graph A, the decline in price resulted in an increase in revenue by

$2 ($30- $28) This focus on revenues permits us to draw the following conclusions concerning the relationship between revenue and price elasticity of demand:

Is elastic Price falls Revenue increases

Is elastic Price rises Revenue decreases

Is inelastic Price falls Revenue decreases

Is inelastic Price rises Revenue increases

Demand is more elastic for goods that have multiple substitutes and less elastic for goods with relatively few substitutes A strategy used by many companies is one that attempts to convince potential customers that the company’s product is sufficiently differentiated from other products that there is no suitable substitute product The company is attempting to create a relatively inelastic demand curve for the product An inelastic demand curve would permit the company to increase price and thus increase revenues In contrast, an elastic demand curve would result in a decrease in revenues if price were increased

Demand also tends to be more inelastic in the short run because it takes time to identify suitable substitutes Thus, the demand for a product tends to be more elastic in the long run than it is in the short run Thus, a strategy of raising prices to take advantage of a relatively inelastic demand curve in the short run could be counterproductive The higher prices could attract competitors and the competitors would offer suitable substitute products In the long run, the demand curve could become elastic because of the increased substitutes Thus, the exploitation of an inelastic demand curve may only be profitable in the long term if the company can sustain a competitive advantage

High value products are more likely to have elastic demand curves than are low value products For high value products, such as automobiles, the consumer is more likely to shop around for substitute products because the potential savings associated with “shopping around” are likely to be great On the other hand, the potential savings from shopping around for low value products, such as candy bars, is not nearly as great

3-3

Now that we have dealt with the demand curve, it is time to turn to the supply curve The supply curve slopes upward and to the right as shown in graph C The intersection of the demand and supply curves is at a price of $3.50 and a quantity of 8 gallons per month The intersection of the demand and supply curves is called the “price equilibrium point” and it determines the price at which the good will be sold and the quantity which will be sold

Demand and Supply Curves for Milk in New York City

Just like demand curves, supply curves may shift to the right or to the left A shift to the right implies that a larger quantity will be supplied for every price point on the supply curve A shift to the left implies that a smaller quantity will be supplied for every price point on the supply curve Listed below are the various causes of a supply curve shift:

• Price of input resources – if the price of input resources declines, the marginal cost declines and the supply curve will shift to the right A larger quantity will be offered at each price point

• Number of suppliers – if the number of suppliers increases, the supply curve will shift to the right In this case, the marginal cost has not changed but more is supplied because of a greater number of suppliers

3-4

• Improved technology – if the technology is improved, the productivity of the supplier is likely to improve This improved technology will reduce the marginal cost and result in the producer supplying a larger quantity for each price point

• Prices of other goods – If the company is capable of producing product A and product B and the price of product B decreases, the company may curtail the production of product B and shift production to product

A In such a situation, the supply curve for product A will shift to the right as the company seeks to utilize the unused capacity occasioned by curtailing the production of product B

• Changes in taxes – A decrease in excise taxes on a product, such as tobacco products, is the same as a reduction in the marginal cost of the product The result is that a reduction in taxes will cause the supply curve to shift to the right An increase in excise taxes will cause the supply curve to shift to the left to represent a reduction in the quantity supplied for each price point

Now that we have dealt with both demand and supply curve, we can discuss the markets in terms of demand, supply,

and the interaction of demand and supply in a perfectly competitive market So far we have spoken of the price

elasticity of demand as being relatively elastic or relatively inelastic It is common for a firm’s demand curve for a particular good to be perfectly elastic even though the demand curve for the entire market for the good to be relatively inelastic This is particularly the case when there is no opportunity for product differentiation and there are many sellers and many buyers The graphs D and E, below, will illustrate that situation:

Market Demand Firm Demand

Units Sold Per Unit Revenue Revenue Revenue

Graph D represents the aggregate market for milk in the New York City region for one month It represents the sum

of the demand for all persons in the New York City region (the earlier Graph A represented the demand curve for

3-5

only one family to keep it simple) In graph D, the supply curve also shows the aggregate marginal cost curve for all producers of milk in the New York City region

Graph E illustrates the demand curve faced by a single producer that sells milk in the New York City region Notice

that the demand curve for that firm is a horizontal demand curve The horizontal demand curve implies a perfectly

elastic demand curve If the producer increases the price from $3.50 per gallon to $3.60 per gallon, he or she will not

be able to sell any milk at all The purchasers of milk will merely purchase their milk from a competitor who continues to sell it at $3.50 per gallon If the producer reduces the price from $3.50 per gallon to $3.40 per gallon, the quantity supplied, as reflected on the firm’s supply curve, would fall to some quantity less than the 500,000 gallons associated with the $3.50 per gallon price Thus, a reduction in price would reduce quantity sold and reduce revenues That implies lower profits No producer faced with a perfectly elastic demand curve would dare to attempt

to sell at a price lower than the market’s equilibrium price That is so because the producer can sell all that he or she can produce at the market price

In such a situation, the producer can improve profits only by lowering the marginal cost of production and shifting the supply curve to the right In such a situation the producer would be selling a larger quantity at the same $3.50 per gallon price and the marginal cost of the last unit produced of the larger quantity would still be no more than $3.50

per gallon Profits would increase! The market structure just described for a commodity type product (such as milk) is regarded as “perfect competition.”

There are other situations (monopolistic competition market structure) in which there are many buyers and a

relatively few sellers The fast food industry is an example of an industry with a market structure that could be described as monopolistic competition In monopolistic competition the demand curve and the marginal revenue curve are not identical This is so because selling a larger quantity of the product can only be accomplished if the price of the product is reduced (unlike a commodity product in a perfectly competitive market) This divergence of the demand and marginal revenue curves is illustrated in Graph F, below:

Demand (D) and Marginal Revenue (MR) Monopolistic Competition

Firms in an industry characterized by monopolistic competition rely on differentiation among products or among suppliers of the products in order to earn more profits In monopolistic competition, there are fewer suppliers with each supplier possessing a modest amount of market power as a result of reduced competition Many retail businesses, personal service businesses, and manufacturing businesses seek to differentiate their product by creating customer loyalty through special services, quality, and location Customer loyalty will cause customers to patronize the company without seeking substitutes for the product In retailing, location is a powerful form of differentiation The retailer with the better location is likely to have a steeper slope to the demand curve than a retailer who has a less desirable location

3-6

The less-than-perfect competition is also caused by barriers to entry into the industry and by the fact that some companies in the industry may have something unique to offer in terms of product, service, or location Barriers to entry such as patents, licenses, franchising, proprietary information, and size of investment, will often limit the number of competitors in the industry Another barrier to entry and source of product differentiation is advertising Advertising and product branding are used by businesses to create and maintain product differentiation and create a subtle barrier to entry

Successful product differentiation and the creation of barriers to entry give the business more monopoly power than other competitors That monopoly power will manifest itself in terms of a relatively more vertical demand curve (less price elasticity of demand)

A Supply chain management system is a means by which firms have been successful in lowering their logistics,

materials management, and distribution costs Supply chain management systems refer to improvement of a

company’s processes for production and delivery services, purchasing, invoicing, inventory management, and distribution The advent of e-commerce has created opportunities for the linking of the various companies in a supply chain from the production of raw materials to the delivery of the finished product to the consumer A properly designed supply chain system creates opportunities for reduction of inventory management costs (possibly less spoiled product), reduced clerical costs (computer matching of invoice with receiving report), improved scheduling of timely delivery of the product to avoid out-of-stock situations (improved logistics) at all levels (producer, processor, wholesaler, and retailer), and improved customer service as a result of the producer being more responsive to the consumer’s product demands

• The lower cost occasioned by the successful implementation of supply chain management will lower the marginal cost of the products produced The lower marginal cost will shift the firm’s supply curve

to the right and encourage the business to produce more of the product or service at the same price

• Thus, the successful implementation of the supply chain management system has the promise of increasing profits to the firm until such time as all in the industry implement supply chain management systems Of course, as more and more firms in the industry successfully implement supply chain management systems, the market’s aggregate marginal cost will decline and the market’s supply curve will shift to the right With no change in the demand curve, the result will be lower prices and larger quantities produced as the market arrives at a new equilibrium price for the product The ultimate result will be a reduction in the price to the consumer as a result of competition among producers

3-7

Chapter Three

Microeconomics with Strategy Emphasis

1 The demand for a good or service depends on all

the following factors EXCEPT:

a The cost to produce it

b The price of the item

c The tastes of consumers

d The prices of substitute and complementary

goods

2 Which of the following statements concerning the

relationship of the quantity demanded or supplied

with price is (are) correct?

(1) The quantity supplied varies inversely with price

(2) The quantity demanded varies directly with price

a (1) only

b (2) only

c Both (1) and (2)

d Neither (1) nor (2)

3 According to economic theory, which of the

following statements is correct?

a A price in excess of the equilibrium price would

lead to a shortage of supply

b A price in excess of the equilibrium price would

lead to an excess of demand

c An equilibrium price can be disrupted by a

rightward or leftward shift of the supply or

demand curve

d An equilibrium price is the price at which all

consumers are able to buy as much as they want

4 A shift in the supply curve downward and to the

right, with the demand curve unchanged, will lead to

which of the following results?

(1) An increase in the equilibrium price

(2) A decrease in the equilibrium quantity

a (1) only

b (2) only

c Both (1) and (2)

d Neither (1) nor (2)

5 When building contractors decide not to build on

speculation but only when a contract to build is executed, it is a signal that wage inflation may be causing a rise in building costs One may conclude from this scenario that:

a The supply curve will remain static as wage inflation increases demand

b The quantity of new homes demanded will decrease, prices will rise, and the supply curve will shift to the left

c The supply curve will shift downward but prices will rise

d The quantity of homes built will decrease along with the price of housing

6 Supply Chain Management systems rely upon which of the following?

a Many suppliers

b Frequent competitive bidding

c Cooperation between purchasing and suppliers

c not be predictable with only these facts

d rise only in the case of an elastic demand function

8 The sum of the average fixed costs and the average variable costs for a given output is known as

a long-run average cost

b average product

c total cost

d average total cost

1 Material from Economics (Bank 1 t/a) by McConnell, published by McGraw Hill,

copyright ©2002, is reproduced with permission of the McGraw-Hill Companies