- CFA Exams
- CFA Level I Exam
- Topic 3. Corporate Issuers
- Learning Module 5. Capital Investments and Capital Allocation
- Subject 3. Capital Allocation Principles and Pitfalls
CFA Practice Question
The post-audit process will improve capital allocation process because ______
II. it encourages adoption of improved forecasting methods.
III. it gives executives incentives to fulfill their forecasts.
I. it helps improve forecast accuracy.
II. it encourages adoption of improved forecasting methods.
III. it gives executives incentives to fulfill their forecasts.
A. I and II
B. I and III
C. I, II and III
Explanation: The purpose of the post-audit process is (1) to improve the accuracy of capital allocation forecasts; (2) to encourage adoption of improved forecasting methods; and (3) to give executives in production, sales, and other areas incentives to work to bring operations in line with forecasts.
User Contributed Comments 8
| User | Comment |
|---|---|
| murli | How capital budgeting give incentives?? I agree that it will improve the operations, but I don't understand the incentive part! |
| hrai1 | I think it inspires the managers to fulfil their budget targets otherwise they would look bad in the audit. Incentive might not be a good word to describe it. |
| aero | hrai1 - good point.... Exam is getting closer |
| MGM13 | I was thinking of "incentives" in monetary terms, so did not include it. On the other hand, I suppose you could consider having or maintaining a rep for meeting forecasts an "incentive". |
| reganbaha | If there is no post-audit then there is no way of knowing if the executives are making reasonable forecasts and assumptions in calculating future CF's etc. But if the executives know that their forecasts will be checked later in post-audit, then it will make them more accountable and give them 'incentives' to use prudent forecasting. |
| Thecatz | i agree with you reganbaha, but the word fulfill implies for me that the executives will do everything possible to fulfill their forecast. And by doing so they could manipulate earnings. And if they do this, this would harm shareholders. |
| Ash12 | It seems as though the LOS for this question provides support for I. and II. but not III. I agree that a post-audit helps management to evaluate prior performance and to improve - but incentivize?? Should we be incentivizing our managers to meet their budgets/forecasts? If so, then we will see manipulation in the earnings due to these pressures - I think the answer key might be incorrect. Any other thoughts? |
| hon132 | Their jobs literally depend on meeting revenue projections, just like any lower job so C is correct. Manipulation is ALWAYS presents, even without an audit process through things like stock options and contract renewals. At least audits strive to be independent to a point. |