Memo

Example:

The partners of Packitup Partnership are considering the decision to convert to the corporate form of business organization. During your discussions with them, you determine that they have only the vaguest ideas about the relationship between corporate debt and equity.

Prepare a memo to the partners of Packitup Partnership describing the concept of solvency, the two main components of corporate capital, and how capital structure decisions affect the risk profile of a firm.

Type your communication below the line in the response area below.

REMINDER: Your response will be graded for both technical content and writing skills. Technical content will be evaluated for information that is helpful to the intended reader and clearly relevant to the issue. Writing skills will be evaluated for development, organization, and the appropriate expression of ideas in professional correspondence. Use a standard business memorandum or letter format with a clear beginning, middle, and end. Do not convey information in the form of a table, bullet point list, or other abbreviated presentation.

To: Packitup Partnership Re: Solvency and capital structure

Level 5 Example To: Packitup Partnership Re: Solvency and capital structure

Solvency is a firm's ability to pay its noncurrent obligations as they come due and thus remain in business in the long run (this is in contrast to liquidity, which is the ability to remain in business in the short run). The key ingredients of solvency are the firm's capital structure and degree of leverage. A firm's capital structure includes its sources of financing, both long- and short-term. These sources can be in the form of debt (external sources) or equity (internal sources).

Debt is creditor interest in the firm. The firm is contractually obligated to repay debtholders. The terms of repayment (i.e., timing of interest and principle) are specified in the debt agreement. As long as the return on debt capital exceeds the amount of interest paid, the use of debt financing is advantageous to a firm. The return is often enhanced due to the fact that interest payments on debt are tax-deductible. The tradeoff is that an increased debt load makes a firm riskier (since debt must be paid regardless of whether or not the company is profitable). At some point, either a firm will have to pay a higher interest rate than its return on debt or creditors will simply refuse to lend any more money.

Equity is the ownership interest in the firm. Equity is the permanent capital on an entity, contributed by the firm's owners in the hopes of earning a return. However, a return on equity is

uncertain because equity embodies only a residual interest in the firms assets (residual because it is the claim left over after all debt has been satisfied). Periodic returns to owners of excess earning are referred to as dividends. The firm may be contractually obligated to pay dividends to preferred stockholders but not to common stockholders.

Capital structure decisions affect the risk profile of a firm. For example, a company with a higher percent of debt capital will be riskier than a firm with a higher percentage of equity capital. Thus, when the relative amount of debt is high, equity investors will demand a higher rate of return on their investments to compensate for risk brought about by the high degree of financial leverage. Alternatively, a company with a relatively larger proportion of equity capital will be able to borrow at lower rates because debt holders will accept lower interest in exchange for the lower risk indicated by the equity cushion.

1.

Westerly Woolens is a growing sole proprietorship that is considering going public. The owner knows that she will have to establish a board of directors, but she is confused by such acronyms as SEC and PCAOB. Additionally, she does not understand the difference between internal audit and external audit.

Prepare a memo to the owner of Westerly Woolens describing the concept of corporate governance and the roles of the following: board of directors, CEO, audit committee, PCAOB, external auditor, and internal audit function. Include the relevant requirements of the Sarbanes-Oxley Act of 2002 (SOX).

Type your communication in the response area below.

REMINDER: Your response will be graded for technical content and writing skills. Technical content will be evaluated for information that is helpful to the intended audience and clearly relevant to the issue. Writing skills will be evaluated for development, organization, and the appropriate expression of ideas in professional correspondence. Use an appropriate business format with a clear introduction, body, and conclusion. Do not convey information in the form of a table, bullet-point list, or other abbreviated presentation.

2.

Deck Co. engages your CPA firm for an external audit of its financial statements for the fiscal year ending June 30, Year 10. After discussions among key engagement team members, fraud risks were identified by (1) making appropriate inquiries, (2) considering fraud risk factors, and (3) evaluating the results of analytical procedures performed as risk assessment procedures.

Write a memorandum describing the appropriate responses to the identified fraud risks.

Type your communication in the response area below.

REMINDER: Your response will be graded for technical content and writing skills. Technical content will be evaluated for information that is helpful to the intended audience and clearly relevant to the issue. Writing skills will be evaluated for development, organization, and the appropriate expression of ideas in professional correspondence. Use an appropriate business format with a clear introduction, body, and conclusion. Do not convey information in the form of a table, bullet-point list, or other abbreviated presentation.

3

Partisan Popsicle Partnership is well known in the area for producing flavored ice products. While the managing partner was meeting with you concerning the preparation of their financial statements, he mentioned that the partnership is going to begin producing paper airplanes. When you asked about the costs of this new product line, the managing partner could only recount the variable cost of producing each paper airplane.

Write a memo to the managing partner of Partisan Popsicle Partnership concerning why he should also be aware of fixed costs, the differences between explicit and implicit costs, and the differences between accounting profits and economic profits.

Type your communication below the line in the response area below.

REMINDER: Your response will be graded for technical content and writing skills. Technical content will be evaluated for information that is helpful to the intended audience and clearly relevant to the issue. Writing skills will be evaluated for development, organization, and the appropriate expression of ideas in professional correspondence. Use an appropriate business format with a clear introduction, body, and conclusion. Do not convey information in the form of a table, bullet-point list, or other abbreviated presentation.

4

You are a finance manager at an investment firm. The CEO has asked you to help train newly hired staff by explaining the difference between leading, lagging, and coincident economic indicators.

Prepare a memo to the new employees discussing the different kinds of indicators, and provide examples of each type of indicator.

Type your communication in the response area below.

REMINDER: Your response will be graded for technical content and writing skills. Technical content will be evaluated for information that is helpful to the intended audience and clearly relevant to the issue. Writing skills will be evaluated for

development, organization, and the appropriate expression of ideas in professional correspondence. Use an appropriate business format with a clear introduction, body, and conclusion. Do not convey information in the form of a table, bullet-point list, or other abbreviated presentation.