Gleim CPA Review Updates to Business 2011 Edition, 1st Printing March 10, 2011

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1 Page 1 of 6 Gleim CPA Review Updates to Business 2011 Edition, 1st Printing March 10, 2011 NOTE: Text that should be deleted from the outline is displayed with a line through the text. New text is shown with a blue background. Study Unit 2 Microeconomics Page 57, Subunit 2.2: This edit deletes extraneous outline material. Candidates should focus on knowing the arc method only. 2.2 ELASTICITY 1. Elasticity of Demand a. Price elasticity of demand (Ed) measures the sensitivity of the quantity demanded of a product to a change in its price. E d = Percentage change in quantity demanded Percentage change in price 1) Elasticity describes the reaction to a change in price from one level to another. Thus, the most accurate way of calculating elasticity is the arc method, which measures elasticity across a range. using averages of the quantities and prices. The following is the algebraically simplified version of the formula: E d = % Δ Q % Δ P = (Q Q ) (Q +Q ) (P 1 P 2 ) (P 1 +P 2 ) a) Both numerator and denominator percentages can be calculated as the change over the range. EXAMPLE Roxy s ice Cream Shoppe sells 100 quarts of chocolate a day at $6 each. If it lowers the price to $3 per quart, it will sell 300 quarts a day. Arc Method Num Denom Num Denom Num Denom Elasticity Change ( ) ($6 $3) = 200 $3 Range ( ) ($6 + $3) 400 $9 = = 1.5 b) Note that aabsolute value is used when calculating coefficients of elasticity.

2 Page 2 of 6 2) An alternative calculation is the point method, which uses the high point of the range instead of the total range for both quantity and price. E d = % Δ Q % Δ P = (Q 1 Q 2 ) Q high (P 1 P 2 ) P high EXAMPLE Using the point method, Roxy s price elasticity of demand is calculated as follows: Point Method Num Denom Num Denom Num Denom Elasticity Change ( ) ($6 $3) 200 $3 = High Point 100 ($6 + $3) 400 $9 3) Comparing the arc method and point method. = = 1.5 a) The point method is obviously computationally simpler, but the arc method is the more accurate of the two. b) When using the point method, use the high end of each range (rather than the starting point). Failing to do so gives the illusion that the elasticity through a given range is different depending on whether price is rising or falling. On the CPA exam, if you are required to calculate an exact coefficient, you will be instructed which method to use. Page 68, Subunit 2.7, Item 3.: These edits correct the marginal costs in the example. 3. Profit Maximization a. As discussed in Subunit 6, the competitive firm must accept the market price and adjust its output accordingly, seeking the level that just covers its average total costs. 1) This results in a competitive firm earning no long-term profits. b. The monopolist, on the other hand, has the power to set output at the level where profits are maximized, that is, where MR = MC. 1) The corresponding price is found with reference to the (downward-sloping) demand curve. a) Note that monopoly does NOT result in the highest possible price, nor does the monopolist produce at the lowest average total cost.

3 Page 3 of 6 EXAMPLE Price Searching for a Monopolist Units of Revenue Cost Profit Output Total Marginal Total Marginal Total Marginal 1 $ 960 $960 $ 800 $800 $ 160 $ , , , , , , , , , , , (120) (220) 7 4, , ,140 0 (300) (780) 8 4, , ,300 (1,040) (480) (1,040) 2) A key point is that, when the monopolist lowers price to increase sales, the price must be reduced for all units. Thus, price = average revenue. If price falls below average variable cost, the firm will cease operations (the shutdown case). Study Unit 3 Macroeconomics Page 106, Subunit 3.8, Item 2.b.: This edit corrects the definition of real interest rate. b. Economists draw a crucial distinction between real and nominal interest rates. 1) The nominal interest rate is the stated rate on a loan. 2) The real interest rate equals the nominal rate plus minus the rate of inflation that the lender expects will be prevalent over the life of the loan. a) The lender must charge this inflation premium in order to compensate for the purchasing power that will be lost while the loan is at the borrower s disposal.

4 Page 4 of 6 Study Unit 4 Globalization Page 148, Subunit 4.2, Question 24.: This edit corrects the arithmetic symbol used in the equation. 24. The British pound is paying a 90-day interest rate of 3.6% and the Japanese yen is paying a 90-day rate of 4%. Interest rate parity (IRP) theory would lead a currency trader to anticipate which one of the following conditions? A. The yen should trade at a forward premium of % with respect to the pound. B. The yen should trade at a forward discount of % with respect to the pound. C. The yen should trade at a forward premium of % with respect to the pound. D. The yen should trade at a forward discount of % with respect to the pound. Answer (A) is correct. (Publisher, adapted) REQUIRED: The true statement about comparative forward exchange rates after applying interest rate parity theory. DISCUSSION: Interest rate parity (IRP) theory holds that exchange rates will settle at an equilibrium point where the difference between the forward rate and the spot rate (i.e., the forward premium or discount) equals the exact amount necessary to offset the difference in interest rates between the two countries. IRP theory can therefore be used to determine the forward premium or discount at which a given foreign currency should be trading. Treating the yen as the domestic currency, the following equation can be solved for the forward premium or discount: [(1 + Domestic interest) (1 + Foreign interest)] 1 = [(1 +.04) ( )] 1 = ( ) 1 = = % premium Answer (B) is incorrect. Since a higher interest rate is being paid on the yen, IRP theory would anticipate a forward premium, not a discount. Answer (C) is incorrect. A premium of % results from reversing the interest rates. Answer (D) is incorrect. A discount of % is the relationship of the pound to the yen, not the yen to the pound. Study Unit 6 Forecasting Analysis Page 197, Questions 8 and 9: These questions have been moved to Subunit 2 to align with outline coverage.

5 Page 5 of 6 Study Unit 7 Corporate Capital Structure Page 233, Subunit 7.6, Question 31: This edit corrects the computation of the after-tax cost of benefits. 31. Maylar Corporation has sold $50 million of $1,000 par value, 12% coupon bonds. Interest is paid annually at a rate of 12%. The bonds were sold at a discount and the corporation received $985 per bond. If the corporate tax rate is 40%, the after-tax cost of these bonds for the first year (rounded to the nearest hundredth percent) is A % B % C % D. 7.09% Answer (A) is correct. (Publisher, adapted) REQUIRED: The after-tax cost of bonds for the first year. DISCUSSION: Interest is 12%, and the annual interest payment on one bond is $120. Thus, the effective rate is 12.18% ($12 $985). Reducing this rate by the 40% tax savings lowers the cost to 7.31%. The after-tax cost of bonds is equal to the coupon rate multiplied by the tax effect 7.2% [12% (100% 40%)]. Answer (B) is incorrect. Multiplying the pretax effective nominal rate of 12.18% ($120 $985) by the tax rate of.40 instead of by (1.40) results in 4.87%. Answer (C) is incorrect. The nominal interest rate is 12%. Answer (D) is incorrect. The after-tax cost of the bonds equals the effective nominal rate times the tax effect. Study Unit 9 Short-Term Financing and Capital Budgeting I Page 303, Subunit 9.6, Question 46: Present value information was added to the question item. 46. Mesa Company is considering an investment to open a new banana processing division. The project in question would entail an initial investment of $45,000, and as a result of the project cash inflows of $20,000 can be expected in each of the next 3 years. The hurdle rate is 10%. What is the profitability index for the project? The present value of an ordinary annuity of 1 discounted at 10% for 3 periods is The present value of 1 due in 3 periods discounted at 10% is.751. A B C D Answer (B) is correct. (Publisher, adapted) REQUIRED: The profitability index. DISCUSSION: At a 10% hurdle rate, the present value of the future inflows is: 20, = $49,740 Thus, the net present value is $4,740 (49,740 45,000). The profitability index calculation is: 49,740 45,000 =

6 Page 6 of 6 Study Unit 12 IT Software and Data Organization Page 388, Subunit 12.5, Question 32: This edit better aligned the question with the outline. 32. An information system (IS) project manager is currently in the process of adding a systems analyst to the IS staff. The new systems analyst will be involved with testing the new computerized system. At which stage of the systems development life-cycle will the analyst be primarily used? A. Cost-benefit analysis. B. Requirements definition. C. Flowcharting. D. Implementation Development. Answer (D) is correct. (Publisher, adapted) REQUIRED: The stage of the systems development lifecycle involving testing of a new system. DISCUSSION: The systems development life-cycle approach is the oldest methodology applied to the development of medium or large information systems. The cycle is analytically divisible into stages: definition, design, development, implementation, and maintenance. Testing, training, and conversion occur is the most crucial step in the implementation development stage of the life-cycle. Answer (A) is incorrect. Cost-benefit analysis is a part of the feasibility study conducted early in the life-cycle. Answer (B) is incorrect. Requirements are defined during the analysis or systems study stage. Answer (C) is incorrect. Flowcharting is a necessary activity in all early stages of the life-cycle. Study Unit 20 Costing Systems and Variances Page 624, Subunit 20.5, Item 5.a.: This edit corrects the standard quality used in the example. EXAMPLE of Direct Labor Variances DV Products produced 98 drums of solvent during the period. It used 932 direct labor hours at a cost of $18 per hour. The variances for direct labor are calculated as follows: AQ AP AQ SP SQ SP 932 hours $ hours $ tons drums 9 $17 $16,776 $15,844 $14,994 Labor Rate Variance Labor Efficiency Variance $932 U $850 U The transaction, including variances, would be recorded as follows: Work-in-process (at standard cost) $14,994 Labor rate variance 932 Labor efficiency variance 850 Wages payable $16,776