Risk Assessment- Exercise #1

Social Konnections Inc. (SKI or the “Company”) is a global Internet company that runs Social Konnections, a large social media networking Web site. SKI has experienced steep growth since its launch in 2005, and the Company went public in 2007. SKI currently has over 500 million active users who visit the site to connect with others, express themselves, and play games.

Last year, substantially all of SKI’s revenue came from advertisers who market their products and services to SKI’s active users through advertisements placed on the Web site or its various mobile platforms.

The founder of the company serves as the CEO and is also on the chairman of the board of directors. The CFO is also one of the co-founders of the company. Both have been serving in these roles since 2005.

In Q1 of the current fiscal year, SKI acquired Corporate Collaborations (CC), an entity that manages private and public social media networks for corporations. CC’s customers are primarily national and global companies whose employees connect over its platform. In addition to hosting private social media networks for corporations, CC provides services to develop the networks it manages. CC’s revenues are earned through the performance of multiyear revenue contracts with its customers. In the current year, CC is expected to produce approximately 20 percent of SKI’s consolidated revenue.

SKI’s investors are focused on the growth prospects of the Company’s legacy open social media platform operations and its new corporate revenue unit. The Company’s MD&A disclosures include (1) various user and revenue metrics to help financial statement users assess its traditional operations and (2) backlog information to help users assess CC’s operations.

Advertising Revenue

SKI creates advertising space on its Web site and mobile applications and sells the space to advertisers either directly, or through advertising agencies. According to Mr. Cook, the

amount an advertiser pays is dependent on the number of views the ad receives or the number of user clicks (depending on the type of advertisement defined in the underlying contract) and the revenue is recorded in the period in which the views or clicks are made.

Ms. Drew has learned that simple advertising can be purchased directly from SKI through SKI’s advertising Web site at standard rates, with the advertisements and terms input directly into the Company’s ad delivery platform. However, most advertising revenue is generated directly through the advertising sales team, which has the ability to help advertisers develop more sophisticated advertising campaigns. Management has established minimum pricing and volume thresholds for these advertisements; however, the sales staff is given significant latitude in securing contracts with customers. Extra commissions are paid to sales individuals who sign longer-term contracts that meet minimum revenue targets.

Once a contract is signed, the ad development department creates the ad content and obtains the customer’s approval. The approved ad and the contract are electronically sent to the ad scheduling department, and the advertisement is uploaded into the Company’s ad delivery platform. The ad delivery platform is a robust system and is designed to capture all the nuances associated with the contract. For example, an advertiser may wish to have its ads displayed only to users whose IP addresses are from a specific geographic location, or the contract may be structured to provide the advertiser with variable pricing or incentives (such as a set of free advertisements) once a certain level has been paid for. In summary, the delivery platform captures all the relevant pricing information associated with the contract to allow for real-time revenue recognition according to the terms of the contract. After the contract is entered into the system, a summary of the contract setup is provided to the sales manager that worked with the customer. The sales manager then reviews the contract setup for accuracy.

The Company’s ad delivery platform automatically tracks the advertising activity each day and reports the activity to its customers, who are then billed weekly for the aggregate ad activity.

Ms. Drew’s Concern

Ms. Drew is concerned about several things she has learned regarding the appropriateness of management’s revenue recognition policies.

Financial Statements

Balance Sheet:

*Assets consist primarily of cash, land/building, patents, goodwill, and other assets.

** As you plan your audit this is the latest financial information available.

Controls

The Company’s has various controls in place. The CFO performs a checklist on a monthly basis to review the performance of the company. The CFO reports to the CEO every quarter. The CEO reports to the chairman of the board of directors once a year before the financial statements are prepared and released to the public.

The company has over 10 thousand employees around the world, of which 4 thousand work at the headquarters. All employees receive the company’s code of ethics that was prepared in 2005 when the company was founded. The CEO was in recent trouble when he posted controversial messages on the social platform that offended people of a certain group. The company has One hundred different controls across the company and across the world related to operations of the company and revenue.

The company uses 10 different IT systems as the company is growing quickly it has had to adopt and adds new systems whenever they are needed.

The leaders of one of the main divisions recently left to go work for Facebook, and has not been replaced for the last 4 months.

Controls have changed a lot since last year because the company is so dynamic and the environment is so fast paced. Employees are always trying to keep up with the new systems and new controls.

Audit

Because of SKI’s continued growth, the audit committee has requested that the Company choose a new audit firm with experience in auditing public technology companies.

Kristine Drew, a senior auditor, is the in-charge accountant on the proposal and planning of the SKI audit. In addition to her supervisory and administrative responsibilities, Ms. Drew is responsible for auditing revenue and determining the risk assessment for the audit.

Ms. Drew has read the Company’s disclosed accounting policies and is interviewing the revenue controller, Bill Cook, and various sales personnel to develop in-depth process flow documentation that will serve as the basis for the team’s risk assessment.

Required:

1. What would you set Audit risk, Control Risk, Inherent Risk, and Detection risk? (Very low, low, medium, or high)
2. Are there are significant or fraud risks that you have identified? (If any why are they fraud or significant risks?)
3. What other information do you need to plan your audit approach? Where would you get this information from? For each piece of information indicate where you might receive it from and how? (ex: who else is on the board of directors- obtained through inquiry.)
4. What benchmark would you use to calculate materiality? Why? (ex: revenue, EBITDA, Equity, Assets, etc)
5. Using the benchmark and guidance in the book calculate “overall materiality” for your audit? (ex: 8% of Equity ($60m)= $2.4m).
6. For Revenue what assertions are the most important for you to test?
7. For Revenue what are your concerns with each of those assertions based on the information above?
8. What are the things about testing revenue that you are concerned about (specifically what parts of the company’s process if any concern you)? (Example: An employee could steal money from the bank account, or revenue could be modified in the accounting software by an employee.) (Focus on the actual real process for the company described above to make this determination.)
9. For your audit approach would you choose to test controls or primarily perform substantive procedures? If so what would be your mix of control testing to substantive testing? (ex: 50% controls, and 50% substantive)
10. Would you accept this audit? If not why not?

Risk Assessment- Exercise #1

Social Konnections Inc. (SKI or the “Company”) is a global Internet company that runs Social Konnections, a large social media networking Web site. SKI has experienced steep growth since its launch in 2005, and the Company went public in 2007. SKI currently has over 500 million active users who visit the site to connect with others, express themselves, and play games.

Last year, substantially all of SKI’s revenue came from advertisers who market their products and services to SKI’s active users through advertisements placed on the Web site or its various mobile platforms.

The founder of the company serves as the CEO and is also on the chairman of the board of directors. The CFO is also one of the co-founders of the company. Both have been serving in these roles since 2005.

In Q1 of the current fiscal year, SKI acquired Corporate Collaborations (CC), an entity that manages private and public social media networks for corporations. CC’s customers are primarily national and global companies whose employees connect over its platform. In addition to hosting private social media networks for corporations, CC provides services to develop the networks it manages. CC’s revenues are earned through the performance of multiyear revenue contracts with its customers. In the current year, CC is expected to produce approximately 20 percent of SKI’s consolidated revenue.

SKI’s investors are focused on the growth prospects of the Company’s legacy open social media platform operations and its new corporate revenue unit. The Company’s MD&A disclosures include (1) various user and revenue metrics to help financial statement users assess its traditional operations and (2) backlog information to help users assess CC’s operations.

Advertising Revenue

SKI creates advertising space on its Web site and mobile applications and sells the space to advertisers either directly, or through advertising agencies. According to Mr. Cook, the

amount an advertiser pays is dependent on the number of views the ad receives or the number of user clicks (depending on the type of advertisement defined in the underlying contract) and the revenue is recorded in the period in which the views or clicks are made.

Ms. Drew has learned that simple advertising can be purchased directly from SKI through SKI’s advertising Web site at standard rates, with the advertisements and terms input directly into the Company’s ad delivery platform. However, most advertising revenue is generated directly through the advertising sales team, which has the ability to help advertisers develop more sophisticated advertising campaigns. Management has established minimum pricing and volume thresholds for these advertisements; however, the sales staff is given significant latitude in securing contracts with customers. Extra commissions are paid to sales individuals who sign longer-term contracts that meet minimum revenue targets.

Once a contract is signed, the ad development department creates the ad content and obtains the customer’s approval. The approved ad and the contract are electronically sent to the ad scheduling department, and the advertisement is uploaded into the Company’s ad delivery platform. The ad delivery platform is a robust system and is designed to capture all the nuances associated with the contract. For example, an advertiser may wish to have its ads displayed only to users whose IP addresses are from a specific geographic location, or the contract may be structured to provide the advertiser with variable pricing or incentives (such as a set of free advertisements) once a certain level has been paid for. In summary, the delivery platform captures all the relevant pricing information associated with the contract to allow for real-time revenue recognition according to the terms of the contract. After the contract is entered into the system, a summary of the contract setup is provided to the sales manager that worked with the customer. The sales manager then reviews the contract setup for accuracy.

The Company’s ad delivery platform automatically tracks the advertising activity each day and reports the activity to its customers, who are then billed weekly for the aggregate ad activity.

Ms. Drew’s Concern

Ms. Drew is concerned about several things she has learned regarding the appropriateness of management’s revenue recognition policies.

Financial Statements

Balance Sheet:

*Assets consist primarily of cash, land/building, patents, goodwill, and other assets.

** As you plan your audit this is the latest financial information available.

Controls

The Company’s has various controls in place. The CFO performs a checklist on a monthly basis to review the performance of the company. The CFO reports to the CEO every quarter. The CEO reports to the chairman of the board of directors once a year before the financial statements are prepared and released to the public.

The company has over 10 thousand employees around the world, of which 4 thousand work at the headquarters. All employees receive the company’s code of ethics that was prepared in 2005 when the company was founded. The CEO was in recent trouble when he posted controversial messages on the social platform that offended people of a certain group. The company has One hundred different controls across the company and across the world related to operations of the company and revenue.

The company uses 10 different IT systems as the company is growing quickly it has had to adopt and adds new systems whenever they are needed.

The leaders of one of the main divisions recently left to go work for Facebook, and has not been replaced for the last 4 months.

Controls have changed a lot since last year because the company is so dynamic and the environment is so fast paced. Employees are always trying to keep up with the new systems and new controls.

Audit

Because of SKI’s continued growth, the audit committee has requested that the Company choose a new audit firm with experience in auditing public technology companies.

Kristine Drew, a senior auditor, is the in-charge accountant on the proposal and planning of the SKI audit. In addition to her supervisory and administrative responsibilities, Ms. Drew is responsible for auditing revenue and determining the risk assessment for the audit.

Ms. Drew has read the Company’s disclosed accounting policies and is interviewing the revenue controller, Bill Cook, and various sales personnel to develop in-depth process flow documentation that will serve as the basis for the team’s risk assessment.

Required:

1. What would you set Audit risk, Control Risk, Inherent Risk, and Detection risk? (Very low, low, medium, or high)
2. Are there are significant or fraud risks that you have identified? (If any why are they fraud or significant risks?)
3. What other information do you need to plan your audit approach? Where would you get this information from? For each piece of information indicate where you might receive it from and how? (ex: who else is on the board of directors- obtained through inquiry.)
4. What benchmark would you use to calculate materiality? Why? (ex: revenue, EBITDA, Equity, Assets, etc)
5. Using the benchmark and guidance in the book calculate “overall materiality” for your audit? (ex: 8% of Equity ($60m)= $2.4m).
6. For Revenue what assertions are the most important for you to test?
7. For Revenue what are your concerns with each of those assertions based on the information above?
8. What are the things about testing revenue that you are concerned about (specifically what parts of the company’s process if any concern you)? (Example: An employee could steal money from the bank account, or revenue could be modified in the accounting software by an employee.) (Focus on the actual real process for the company described above to make this determination.)
9. For your audit approach would you choose to test controls or primarily perform substantive procedures? If so what would be your mix of control testing to substantive testing? (ex: 50% controls, and 50% substantive)
10. Would you accept this audit? If not why not?

Risk Assessment- Exercise #1

Social Konnections Inc. (SKI or the “Company”) is a global Internet company that runs Social Konnections, a large social media networking Web site. SKI has experienced steep growth since its launch in 2005, and the Company went public in 2007. SKI currently has over 500 million active users who visit the site to connect with others, express themselves, and play games.

Last year, substantially all of SKI’s revenue came from advertisers who market their products and services to SKI’s active users through advertisements placed on the Web site or its various mobile platforms.

The founder of the company serves as the CEO and is also on the chairman of the board of directors. The CFO is also one of the co-founders of the company. Both have been serving in these roles since 2005.

In Q1 of the current fiscal year, SKI acquired Corporate Collaborations (CC), an entity that manages private and public social media networks for corporations. CC’s customers are primarily national and global companies whose employees connect over its platform. In addition to hosting private social media networks for corporations, CC provides services to develop the networks it manages. CC’s revenues are earned through the performance of multiyear revenue contracts with its customers. In the current year, CC is expected to produce approximately 20 percent of SKI’s consolidated revenue.

SKI’s investors are focused on the growth prospects of the Company’s legacy open social media platform operations and its new corporate revenue unit. The Company’s MD&A disclosures include (1) various user and revenue metrics to help financial statement users assess its traditional operations and (2) backlog information to help users assess CC’s operations.

Advertising Revenue

SKI creates advertising space on its Web site and mobile applications and sells the space to advertisers either directly, or through advertising agencies. According to Mr. Cook, the

amount an advertiser pays is dependent on the number of views the ad receives or the number of user clicks (depending on the type of advertisement defined in the underlying contract) and the revenue is recorded in the period in which the views or clicks are made.

Ms. Drew has learned that simple advertising can be purchased directly from SKI through SKI’s advertising Web site at standard rates, with the advertisements and terms input directly into the Company’s ad delivery platform. However, most advertising revenue is generated directly through the advertising sales team, which has the ability to help advertisers develop more sophisticated advertising campaigns. Management has established minimum pricing and volume thresholds for these advertisements; however, the sales staff is given significant latitude in securing contracts with customers. Extra commissions are paid to sales individuals who sign longer-term contracts that meet minimum revenue targets.

Once a contract is signed, the ad development department creates the ad content and obtains the customer’s approval. The approved ad and the contract are electronically sent to the ad scheduling department, and the advertisement is uploaded into the Company’s ad delivery platform. The ad delivery platform is a robust system and is designed to capture all the nuances associated with the contract. For example, an advertiser may wish to have its ads displayed only to users whose IP addresses are from a specific geographic location, or the contract may be structured to provide the advertiser with variable pricing or incentives (such as a set of free advertisements) once a certain level has been paid for. In summary, the delivery platform captures all the relevant pricing information associated with the contract to allow for real-time revenue recognition according to the terms of the contract. After the contract is entered into the system, a summary of the contract setup is provided to the sales manager that worked with the customer. The sales manager then reviews the contract setup for accuracy.

The Company’s ad delivery platform automatically tracks the advertising activity each day and reports the activity to its customers, who are then billed weekly for the aggregate ad activity.

Ms. Drew’s Concern

Ms. Drew is concerned about several things she has learned regarding the appropriateness of management’s revenue recognition policies.

Financial Statements

Balance Sheet:

*Assets consist primarily of cash, land/building, patents, goodwill, and other assets.

** As you plan your audit this is the latest financial information available.

Controls

The Company’s has various controls in place. The CFO performs a checklist on a monthly basis to review the performance of the company. The CFO reports to the CEO every quarter. The CEO reports to the chairman of the board of directors once a year before the financial statements are prepared and released to the public.

The company has over 10 thousand employees around the world, of which 4 thousand work at the headquarters. All employees receive the company’s code of ethics that was prepared in 2005 when the company was founded. The CEO was in recent trouble when he posted controversial messages on the social platform that offended people of a certain group. The company has One hundred different controls across the company and across the world related to operations of the company and revenue.

The company uses 10 different IT systems as the company is growing quickly it has had to adopt and adds new systems whenever they are needed.

The leaders of one of the main divisions recently left to go work for Facebook, and has not been replaced for the last 4 months.

Controls have changed a lot since last year because the company is so dynamic and the environment is so fast paced. Employees are always trying to keep up with the new systems and new controls.

Audit

Because of SKI’s continued growth, the audit committee has requested that the Company choose a new audit firm with experience in auditing public technology companies.

Kristine Drew, a senior auditor, is the in-charge accountant on the proposal and planning of the SKI audit. In addition to her supervisory and administrative responsibilities, Ms. Drew is responsible for auditing revenue and determining the risk assessment for the audit.

Ms. Drew has read the Company’s disclosed accounting policies and is interviewing the revenue controller, Bill Cook, and various sales personnel to develop in-depth process flow documentation that will serve as the basis for the team’s risk assessment.

Required:

1. What would you set Audit risk, Control Risk, Inherent Risk, and Detection risk? (Very low, low, medium, or high)
2. Are there are significant or fraud risks that you have identified? (If any why are they fraud or significant risks?)
3. What other information do you need to plan your audit approach? Where would you get this information from? For each piece of information indicate where you might receive it from and how? (ex: who else is on the board of directors- obtained through inquiry.)
4. What benchmark would you use to calculate materiality? Why? (ex: revenue, EBITDA, Equity, Assets, etc)
5. Using the benchmark and guidance in the book calculate “overall materiality” for your audit? (ex: 8% of Equity ($60m)= $2.4m).
6. For Revenue what assertions are the most important for you to test?
7. For Revenue what are your concerns with each of those assertions based on the information above?
8. What are the things about testing revenue that you are concerned about (specifically what parts of the company’s process if any concern you)? (Example: An employee could steal money from the bank account, or revenue could be modified in the accounting software by an employee.) (Focus on the actual real process for the company described above to make this determination.)
9. For your audit approach would you choose to test controls or primarily perform substantive procedures? If so what would be your mix of control testing to substantive testing? (ex: 50% controls, and 50% substantive)
10. Would you accept this audit? If not why not?

A common tactic to manage earnings is to “stuff the channels”, that is, to ship product prematurely to dealers and customers, thereby inflating sales for the period. A case in point is Bristol-Myers Squibb Co. (BMS), a multinational pharmaceutical company headquartered in New York. In August 2004, the SEC announced a $150 million penalty levied against BMS. This was part of an agreement to settle charges by the SEC that the company had engaged in a fraudulent scheme to inflate sales and earnings in order to meet analysts’ earnings forecasts.

The scheme involved recognition of revenue on pharmaceutical products shipped to its wholesalers in excess of the amounts demanded by them. These shipments amounted to $1.5 billion U.S. during 2001-2002. To persuade its wholesalers to accept this excess inventory, BMS agreed to cover their carrying costs, amounting to millions of dollars per quarter. In addition, BMS understated its accruals for rebates and discounts allowed to its large customers.

According to the SEC, the company also engaged in “cookie jar” accounting. That is, it created phony reserves for disposals of unneeded plants and divisions during high-profit quarters. These would be transferred to reduce operating expenses in low-profit quarters when BMS’s earnings still fell short of amounts needed to meet forecasts.

Required:

1. Give reasons why managers would resort to extreme earnings management tactics such as these.

[4 marks]

2. Evaluate the effectiveness of stuffing the channels as an earnings management device. Consider both from the standpoint of a single year and over a series of years.

[5 marks]

1. Evaluate the effectiveness of cookie jar accounting as an earnings management device.

25. Revenue recognition is a major accounting challenge. Most industrial and retail firms recognize revenue as earned at the point of sale. More generally, according to IAS 18, revenue from the sale of goods should be recognized when the significant risks and rewards of ownership have been transferred to the buyer, the seller loses control over the items, the revenue and related costs can be measured reliably, and collection is reasonably assured. Revenue from services and long-term contracts can be recognized as the work progresses.

It is often not clear just when these general criteria are met. For example, revenue recognition at point of sale may be a reasonable tradeoff between relevance and reliability in most cases. However, relevance is increased (and reliability decreased) if revenue is recognized earlier than point of sale.

Furthermore, revenue recognition policy may be used by firms to impress investors. For example, firms with no earnings history (e.g., startup firms) and firms that are incurring significant losses or declines in earnings have an incentive to record revenue as early as possible, so as to improve, at least temporarily, the appearance of their financial statements.

Consider the case of Lucent Technologies Inc. (now called Alcatel-Lucent). In December 2000, Lucent restated its revenue for its fiscal year ended September 30, 2000, reducing the amounts (in millions) originally reported as follows:

The vendor financing component of the restatement represents previously unrecorded credits granted by Lucent to customers, to help them finance purchases of Lucent products. That is, the customer sales were originally recorded gross, rather than net, of the credits. The distribution partners’ component represents product

shipped to firms with which Lucent did not deal at arm’s length, but which was not resold by these firms at year-end. These firms included certain distributors in which Lucent had an ownership interest. The practice of over shipping to distributors is called “stuffing the channels.”

In its 2000 annual report, Lucent reported net income of $1,219 million, compared to $4,789 million for 1999 and $1,065 million for 1998.

Despite these December, 2000 adjustments, on May 17, 2004, the SEC announced charges against Lucent and several of its officers for overstating revenues by $1,148 million in 2000 in order to meet sales targets. The company’s share price fell by 5.5% on that day. Tactics used, the SEC claimed, included the granting of improper credits to customers to encourage them to buy company products, and invoicing sales to customers that were subject to renegotiation in subsequent periods.

Subsequently, Lucent paid a fine of $25 million for “lack of cooperation.” In addition, the company, and some of the executives charged, settled the allegations by paying penalties, without admitting or denying guilt.

Required

a. What is the most relevant point of revenue recognition? The most reliable? Explain. In your answer, consider manufacturing firms, oil and gas exploration firms, retail firms, and firms with long-term contracts.

b. Explain whether or not you feel that Lucent’s original recognition of the $679 million of items listed above as revenue was consistent with revenue recognition criteria? While Lucent was a U.S. company, assume that U.S. revenue recognition criteria are similar to the IASB criteria given in the question. In your answer, consider the tradeoff between relevance and reliability.

c. What additional revenue recognition questions arise when the vendor has an ownership interest in the customer?

a) Suppose that both a call and a put are traded on the stock of ABC Company; both have strike prices of $30 and mature in one-year. What is the payoff to the call option if the stock price is $25 at the end of the year?

b) Suppose that both a call and a put are traded on the stock of ABC Company; both have strike prices of $30 and mature in one-year. What is the payoff to the call option if the stock price is $35 at the end of the year?

c) Suppose that both a call and a put are traded on the stock of ABC Company; both have strike prices of $30 and mature in one-year. What is the profit to the call option if the option premium is $3 and the stock price is $35 at the end of the year?

d) Suppose that both a call and a put are traded on the stock of ABC Company; both have strike prices of $30 and mature in one-year. What is the profit to the put option if the option premium is $4 and the stock price is $35 at the end of the year?

1. The Cases:

Starbucks Global Quest in 2006: Is the Best Yet to Come?

Since 1987, Starbucks had transformed itself from a modest 9-store operation in the Pacific Northwest into a powerhouse multinational enterprise with 10,241 store locations, including some 2,900+ stores in 30 foreign countries. During Starbucks early years when coffee was a 50-cent morning habit at local diners and fast food establishments, skeptics had ridiculed the notion of $3 coffee as a yuppie fad. But the popularity of Starbucks’ Italian-style coffees, espresso beverages, teas, pastries and confections had made Starbucks one of the great retailing stories of recent history and the world’s biggest specialty coffee chain. In 2003, Starbucks made the Fortune 500, prompting CEO Howard Schultz to remark, “It would be arrogant to sit here and say that 10 years ago we thought we would be on the Fortune 500. But we dreamed from day one and we dreamed big.”

Starbucks reported revenues in fiscal 2005 of $ 6.4 billion, up 205% from $2.1 billion in fiscal 2000; after-tax profits in 2005 were $494.5 million, an increase of 423% from fiscal 2000 net earnings of $94.6 million.

Having positioned Starbucks as the dominant retailer, roaster, and brand of specialty coffees and coffee drinks in North America and spawned the creation of the specialty coffee industry, management’s long-term objective was now to establish Starbucks as the most recognized and respected brand in the world. In 2005, new stores were being opened at the rate of roughly 32 per week and management expected to have 15,000 Starbucks stores open worldwide going into 2006. Believing that the scope of Starbucks long-term opportunity had been underestimated, Schultz had recently increased the targeted number of stores from 25,000 to 30,000 worldwide by 2013, at least half of which were to be outside the United States. He noted that Starbucks only had an overall 7% share of the coffee drinking market in the United States and perhaps a 1% share internationally. According to Schultz, “85that still leaves lots of room for growth. Internationally, we are still in our infancy.” Although coffee consumption worldwide was standing, coffee was still the second most consumed beverage in the world, trailing only water.

In fiscal 2006, Starbucks planned to open 1,800 net new stores globally. Top management believed that it could grow revenues by about 20 percent annually and net earnings by 20-25 percent annually for the next 3 to 5 years. Howard Schultz and CEO Jim Donald viewed China as a huge market opportunity, along with Brazil, India, and Russia. To sustain the company’s growth and make Starbucks one of the world’s preeminent global brands, Howard Schultz believed that the company had to challenge the status quo, be innovative, take risks, and adapt its vision of who it was, what it did, and where it was headed. If the challenge of executing the company’s strategy was met successfully, in all likelihood the company’s best years lay on the strategic road ahead.

Questions

Part I: Multiple Choice Questions. Having read the above case, now please answer the following Multiple Choice Questions. You need to write justification of your answer briefly.

1. What are the key elements of Starbucks’ strategy as of 2006? And what does it reflect?

a. Expand the number of Starbucks stores domestically and this reflects the clear mission, vision and strategy

b. Continue the drive to make Starbucks a global brand by opening stores in an increasing number of foreign locations which reflects corporate level plan and the process of its strategy

c. Multiple store formats/designs that are attractive, visible, and appealing and this reflects the management process

d. All of the above are applicable

Jus

2. Starbucks management viewed each store as a billboard for the company and as a contributor to building the company’s brand and image. Each detail was inspected to improve the mood and ambience of the store, to make sure everything signaled “best-of-class” and reflected the personality of the community and the neighborhood. The thesis was “everything mattered.” The company went to great lengths to make sure the store fixtures, the merchandise displays, the colors, the artwork, the banners, the music, and the aromas all blended to create a consistent, inviting, stimulating environment that evoked the romance of coffee, that signaled the company’s passion for coffee, and that rewarded customers with ceremony, stories, and surprise. This reflects:

a. business level and functional level strategies

b. corporate level strategies

c. mission and vision

d. standing plans

Justi

3. Which of the following is true about Starbucks?

a. A big emphasis on store ambience the idea was to heighten the “third place” Starbucks experience for customers.

b. To try to keep the coffee aromas in the stores pure, smoking was banned and employees were asked to refrain from wearing perfumes or colognes

c. Prepared foods were kept covered so customers would smell coffee only

d. All of the above are true and applicable

J

4. Colorful banners and posters were used to keep the look of Starbucks stores fresh and in keeping with seasons and holidays. Company designers came up with artwork for commuter mugs and T-shirts in different cities that were in keeping with each city’s personality. If we were to look at the link with the theories of management, this would be in line with:

a. Scientific management

b. the theory of Bureaucracy

c. the Open Systems View

d. Management Science Theory

Justific------

5. Another strategy by Starbucks is to provide Internet access and digital entertainment. The objective was to heighten the “third place” Starbucks experience, attract customers into perhaps buying a second latte or espresso while they caught up on email, listened to digital music, put the finishing touches on a presentation, or accessed their corporate intranet. This reflects that Starbucks is also applying:

a. Dynamic Capabilities Theory

b. Theory X and Theory Y

c. Contingency Theory

d. The Gilbreths

Justi

6. Which of the following statements are true and why? Link it to topics you have covered

a. Starbucks is a company that definitely places a high strategic priority on building and strengthening the Starbucks brand name—and it uses every tactic it can to polish its image and extend its name by entering new market niches and geographic markets.

b. Howard Schultz has long made it clear that making Starbucks one of the top brand names worldwide is high on his strategic agenda.

c. Howard Schultz deserves a solid A or A– for his performance as CEO and Chairman.

d. All of the above are true

-----

7. Schultz has been in the forefront of arranging the company’s strategy implementation / execution effort. His notable achievements here include:

a. Building an organization capable of sustaining rapid growth while still preserving and enhancing the quality/image of Starbucks products.

b. Hiring key executives/building a strong top management team and making sure the company has the requisite support systems/corporate infrastructure

c. Leading the effort to design/redesign the company’s stores as well as instituting motivational incentives aimed a making Starbucks a great place to work

d. All of the above are applicable

8. Which of the following issues could face Starbucks as of 2005?

a. How to sustain the company’s rapid growth

b. Will the domestic market for stores soon become saturated (will the U.S. market support 15,000 retail stores—which is about double the number at the end of fiscal year 2005?)

c. Will the company need to open company-owned stores in foreign countries rather than continuing with the present strategy of licensing so many (which generates royalty revenues and perhaps some profits from supplying coffee to foreign licensees)?

d. All of the above issues are applicable

Ju

9. How can Starbucks establish motivational incentives aimed at making Starbucks a great place to work? All of the following can be considered EXCEPT:

a. Extend health-care benefits to part-time workers

b. Cooperating with the government

c. An attractive additional benefit program  

d. Functioning as cultural and spiritual leader

10. The following are considered as core values of Starbucks EXCEPT:

a. Making Starbucks a great place to work

b. Operating the business in an ethical and socially responsible manner

c. High technology

d. Dedication to product quality

1.)During April, Elsa Corporation budgeted for 27,000 customers, but actually served 23,000 customers. The company uses the following revenue and cost formulas in its budgeting, where q is the number of customers served:

Revenue: $4.10q

Wages and salaries: $33,300 + $1.10q

Supplies: $0.70q

Insurance: $8,600

Miscellaneous expense: $3,700 + $0.40q

Prepare the company's flexible budget for April based on the actual level of activity for the month.

2.)Buehler Diner is a charity supported by donations that provides free meals to the homeless. The diner's budget for October was based on 3,400 meals, but the diner actually served 3,200 meals. The diner's director has provided the following cost formulas to use in budgets:

                                               Fixed Element per Month Variable Element per Month

Groceries …………………….. $0 $2.80

Kitchen Operations………….. $5300 $1.75

Administrative expense …….. $3600 $0.75

Fundraising expenses………… $1500 $0

Compute the activity variance for administrative expenses caused by serving less meals than expected. State answer as positive number.

3.)Gettys Corporation bases its budgets on the activity measure customers served. During October, the company planned to serve 24,000 customers, but actually served 28,000 customers. The company has provided the following data concerning the formulas it uses in its budgeting:

                                                 Fixed Element per Month Variable Element per Month

Revenue …………………….. $0 $4.90

Wages and Salaries………… $29900 $1.90

Supplies………………. …….. $0 $0.70

Insurance…………..………… $9100 $0

Misc Expense…………………. $5500 $0.10

Compute the revenue activity variance. State your answer as a positive.

4.)Gettys Corporation bases its budgets on the activity measure customers served. During October, the company planned to serve 24,000 customers, but actually served 28,000 customers. The company has provided the following data concerning the formulas it uses in its budgeting:

                                                     Fixed Element per Month Variable Element per Month

Revenue …………………….. $0 $4.90

Wages and Salaries………… $29900 $1.90

Supplies………………. …….. $0 $0.70

Insurance…………..………… $9100 $0

Misc Expense…………………. $5500 $0.10

Compute the total expense activity variance. State your answer as a positive.

5.) Kaylar Clinic uses patient-visits as its measure of activity. During September, the clinic budgeted for 3,000 patient-visits, but its actual level of activity was 2,900 patient-visits. The clinic has provided the following data concerning the formulas used in its budgeting and its actual results for September:

Data used in budgeting:

                                                 Fixed Element per Month Variable Element per Month

Revenue …………………….. $0 $37.20

Personal Expenses…………. $27600 $11.30

Medical Expenses………….. $1500 $6.80

Occupancy Expenses…….... $6200 $1.70

Administrative Expenses…... $3600 $0.30

Actual results for September:

Revenue …………………….. $105010                                   

Personal Expenses…………. $61020                                   

Medical Expenses………….. $22120                                   

Occupancy Expenses…….... $10930                                 

Administrative Expenses…... $4570

Compute the total Revenue variance (due to a difference in the actual amount collected per customer from expected). State answer as a positive.

Assignment 3: Data Analysis with Graphs Assignment

• Data Set A Masses, to the nearest kilogram, of 30 men: 74 52 67 68 71 76 86 81 73 64 75 71 57 67 57 59 72 79 64 70 77 79 65 68 76 83 61 63 68 74
• Data Set B Times, in seconds, taken by 20 boys to swim one length of a pool 32 31 26 27 27 32 29 26 25 25 31 33 26 30 23 32 27 26 31 29

1. how would you draw a stem and leaf diagram for each of the above data sets.

2.Using your stem and leaf diagrams, make at least 2 comments about each set of data (i.e., what does the diagram tell you about the data?).

3.For each of the data sets:

a.Create a histogram from the data.

b.Does the histogram tell you anything that wasn’t evident from the stem and leaf diagram? Does it make anything about the data more difficult to see?

c.Create a second histogram with a different bin width. How does this change how you interpret the data?

4.For each of the data sets, explain whether you prefer the stem and leaf diagram or a histogram and why?

The following data pertain to the Marie Manufacturing Company for the year ended December 31, 2004. The company used 51,000 direct labor hours during 2004.

Beginning direct material inventory                           $    42,000
Ending direct material inventory 48,000
Beginning work-in-process inventory 84,000
Ending work-in-process inventory 93,000
Beginning finished goods inventory 124,000
Ending finished goods inventory 133,000
Direct material purchased 850,000
Indirect material used in production 4,000
Factory supplies used 6,200
Depreciation on the factory 60,000
Depreciation on the sales office 4,000
Depreciation on the administrative office 3,000
Sales salaries 120,000
Sales revenue 3,335,000
Assembly-line labor cost 820,000
Factory security guard cost 12,000
Factory supervision 82,600
Depreciation on production equipment 560,000
Depreciation on sales office equipment 22,200

Additional Information:

The overhead is applied using a budgeted rate that is set every December by forecasting the following year's production (in units) and relating it to forecast direct labor hours. The budget for 2004 called for 50,000 direct labor hours and $750,000 of factory overhead.     

• What is the adjusted cost of goods manufactured?

Group of answer choices

$ 815,000

$2,420,000

$ 844,000

$ 40,200

$2,411,000

$2,370,800