Comprehensive MACCT Examination

Spring 2005

  1. a. Describe carefully three provisions of Sarbanes-Oxley that relate to management responsibilities and assess the effectiveness of each in remedying the underlying problems that led to passage of the bill.

b. Repeat the answer in a. for the auditor.

c. Select from your answers to a. and b. above, select the single most important provision and provide justification or your choice.

2.Vick Foote, the CFO of your client, Sasquatch Inc., has called you with a question regarding earnings per share. Currently, Sasquatch has 5,000,000 shares of common stock and bonds convertible into 1,000,000 shares of common stock. The board of directors is considering issuing 2,000,000 shares of 8% cumulative preferred stock. The preferred stock is not convertible. However, preferred shareholders would be entitled to participate on a 1:1 basis in any per share dividend distributed to common shareholders, in addition to their cumulative 8% dividend. However, the maximum amount of the total dividend to preferred shareholders cannot exceed 10% of the market price of the common stock on the date the dividends are declared.

Vick wants you to research two issues:

  1. Will the new participating security be treated as a second type of common stock for purposes of computing earnings per share? That is, will it require the use of the “two-class method”?
  2. How will basic and diluted earnings per share be presented if the two-class method is required? Vick is concerned with the confusion and complications that might result if two different sets of earnings per share figures are reported.

3. Managerial motivation is a problem for ABC Corp. in two contexts. First, one of the problems of entering into contracts, including executive compensation contracts, is incompleteness. That is, it is generally impossible to foresee all contingencies that might happen and build provisions for them into the contract. An example of contract rigidity in the face of an unforeseen event appeared in a Wall Street Journal article entitled “Firms Get Around Big One-Time Earnings Hits to Save Executive Bonuses.”

The article discusses SFAS 106, which requires firms accrue employees’ other post-employment benefits, rather than waiting until they are paid. The article states because of SFAS 106 “many compensation committees want to use operating earnings—not net after the accounting change—to calculate top managers’ bonuses.”

ABC Corp., which had a charge for retiree health costs of $5 billion last year, plans to ask its shareholders if it could exclude the charge to calculate bonuses. However, there is opposition by the United Shareholders Association, who believes charges such as postretirement benefits should be deemed a regular business cost, not an unusual expense to be ignored by board compensation committees. However, ABC’s consulting firm says it is simpler to exclude the new annual charge than to alter the bonus formula.

ABC’s second managerial motivation problem involves the middle management ranks. Specifically, the company has a number of divisions that are profit centers, all sharing a common machine shop. The user divisions are always submitting rush orders to the operator of the machine shop. One division, Division A, frequently claims an order is urgent and delay will result in a significant loss to the company, a claim that is very difficult for the operator of the machine shop to verify or refute. This sometimes results in a job being given priority, which causes the delay of another division’s job, where the cost of delay to the company is well in excess of the cost of delay to division A. Each division manager receives a bonus based solely on the profits of his or her division, in addition to a fixed salary.

Required:

  1. If you were an ABC shareholder, would you agree to exclude the charge for retiree health costs from the bonus calculation? Explain why or why not.
  1. If you were a senior ABC executive affected by SFAS 106 and your request exclude the $5 billion charge was turned down, how would you react? Explain why.
  1. Explain why the behavior of division A’s manager is predictable, in terms of agency theory.
  1. Can you think of a solution to the middle management agency problem? Explain why your solution works.

4.

Part A: Risk and Information Technology

Some argue that information technology has made enterprise internal control systems more difficult to design and use. Others take the position that information technology has made it easier to control enterprise risks. What is your position? Explain.

Part B:

You have been contacted by one of your clients to prepare a proposal for a new technology-based information system. The client has been reading about information system design and implementation and has come across the concept of information system modeling. One of the sources he read referred to conceptual models, logical models and physical models. He is confused about the need for three different models for one system. Prepare an explanation to the client about the need for the different models – and in particular, how the models differ from each other.