Fall, 2006 - Comprehensive Exam Questions

You must complete all four questions no later than 3:00 PM. Please email answers to each question in a SEPARATE file that includes your name and the question number (e.g., Smith-Q1.doc). Your name should also appear at the top of each question (for those graders who choose to print your answers). In addition to sending the 4 files to and , you should send one to yourself AND save a copy on the “memory stick” Amber will provide.

1. Accounting Information Systems.

a. Some would argue that the accounting information system should be fully integrated as a part of an enterprise’s management information system. Others are equally persuaded that an organization should separate the accounting system from the other information systems of an entity. What do you think? Why? Explain your position.

b. Information system security is an important element to be considered in the design, implementation, and operation of an information system. A client has approached you about a new information system for their business. However, they have concerns about information security issues. The client asks you to explain your approach to resolving their concerns about information system security. In other words, (1) how will you determine what risks are present or likely and (2) how will you determine if those risks can be resolved?

2. Accounting Theory . KLM Inc.’s management team is concerned about the new pension accounting rules (FASB No. 158, Sept. 2006). Under this standard, net income will be the same but comprehensive income will probably be 15% lower than in the past. Liabilities will be 10 to 15% higher and stockholders’ equity will be about 20% lower. Complete information about the projected benefit obligation and plan assets were previously disclosed only in the notes to the financial statements.

KLM’s executive compensation is comprised of salary, cash bonuses for meeting specific performance objectives, and stock options that that generally vest after 3 years and must be exercised within ten years from issue. Over the last five years, salary has averaged 60% of total compensation with 15% from bonuses and the remainder from the fair value of options received. At this point in time, about half of the options held by executives are “under water” (i.e., the exercise price is higher than the market price.) Executives do not have to own KLM stock but most of them are stockholders with holdings ranging from 10% to 20% of annual salary.

a.  Using agency theory concepts, explain why management might be worried about the changes in its financial statements that result from the FASB No. 158 pension standard.

b.  Critique the management compensation contract. Consider the precision and sensitivity of measurement of management performance. Should the new standard cause reconsideration of the current compensation plan? If so, what would you suggest?

c.  Assuming an efficient capital market, what effect should the new standard have on security prices and shareholder wealth? Explain.

d.  If you were an accounting professor, how might you research the impact of the new standard? What research methodologies and data would you use?

3. Auditing Question. Sarbanes Oxley has changed the environment of auditing substantially.

a.  Discuss SOX Section 404 from the public company’s perspective. How has SOX Section 404 changed the public company’s responsibility regarding internal control?

b.  Discuss SOX Section 404 from the external auditors’ perspective. How has SOX Section 404 and PCABO Statement Number 2 changed the external audit firm’s responsibilities regarding the company’s internal control system?

c.  SAS No. 99 requires the auditor(s) to gather and consider information to assess fraud risks. (1) Discuss the three components of the “fraud triangle” (2) Describe a specific example for each component of the “fraud triangle.” (3) For each of the three examples, discuss an audit procedure that the auditor can perform to assess the specific risk.

4. FARS Research Question

Assume that you are working for a public accounting firm. Super Mines Inc., a client company, has contacted you for help in interpreting the proper procedures for conducting an impairment test of its kryptonite mine. This is its first ever impairment test and it was triggered by a recent drop in the selling price for kryptonite. The client is asking for specific guidance about the estimated future cash flows that will be used to test for recoverability. The asset group being tested includes the mine and related long-lived assets (plant and equipment).

Background. The geologists at Super Mines have estimated the total tons of material that can be extracted from the open-pit mining site. The raw material must be processed in order to extract the kryptonite. As the active mining area expands along the geological structure of the mine, new processing plants must be constructed near the production area. The previous processing plant is torn down after the new plant is constructed. The current processing plant has an estimated useful life of three more years at the current rate of production. Over the life of the mine, an estimated five additional processing plants will be constructed. Super Mines is required to restore the land to forest after the mining is complete but it has not recorded a liability for this restoration under the provision of FASB No. 143 because it does not intend to close the mine in the foreseeable future and because there is considerable uncertainty with respect to the costs of the restoration if and when the mine is closed. The mine is currently operating at a loss but management expects the mine to regain profitability in the future. However, if the price of kryptonite remains low for an extended period of time, the company might be forced to abandon or sell the mine.

In a letter to the client, explain whether the following four specific items should be included in among the cash flows used in the impairment test:

a.  The cost of building the five additional processing plants

b.  The cost of tearing down the current processing plant (and the five additional processing plants if they are included in the cash flows).

c.  The cost of labor and materials to mine and process the kryptonite over the anticipated productive life of the mine.

d.  Environmental exit costs related to restoring the property to forest land at completion of the mining operation.

Limit your answer to the specific issues listed. You do not need to explain the FASB No. 144 impairment test rules. In your letter, you should avoid long quotations but you may attach relevant passages from the standards to your letter.

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