1.
Compute inherent risk.
1.
Answer to Problem 20BEA
Inherent risk is $24,000,000.
Explanation of Solution
Inherent Risk:
Inherent risk is a risk that prevails in a system before any control measure is adopted within an organization.
Computation of inherent risk:
Inherent risk can be computed by using the following formula:
Substitute $80,000,000 for impact and 30% for the probability of occurrence in the above formula.
Therefore, inherent risk is $24,000,000.
2.
Compute residual risk of each of the three alternatives.
2.
Answer to Problem 20BEA
Residual risk for alternative A, B, and C is $16,000,000, $7,500,000, and $24,000,000 respectively.
Explanation of Solution
Residual risk can be computed by using the following formula:
Computation of residual risk for alternative A:
Substitute $80,000,000 for impact and 20% for the probability of occurrence in the above formula.
Computation of residual risk for alternative B:
Substitute $50,000,000 for impact and 15% for the probability of occurrence in the above formula.
Computation of residual risk for alternative C:
Substitute $80,000,000 for impact and 30% for the probability of occurrence in the above formula.
Therefore, residual risk for alternative A, B, and C is $16,000,000, $7,500,000, and $24,000,000 respectively.
3.
Compute benefit from each of the three alternatives.
3.
Answer to Problem 20BEA
Benefitfrom alternatives A, B, and C is $8,000,000, $16,500,000, and $0 respectively.
Explanation of Solution
Benefit from a risk response alternative can be computed by using the following formula:
Computation of response benefit from alternative A:
Substitute $24,000,000 for inherent risk and $16,000,000 for residual risk in the above formula.
Computation of response benefit from alternative B:
Substitute $24,000,000 for inherent risk and $7,500,000 for residual risk in the above formula.
Computation of response benefit from alternative C:
Substitute $24,000,000 for inherent risk and $24,000,000 for residual risk in the above formula.
Therefore, benefit from alternatives A, B, and C is $8,000,000, $16,500,000, and $0 respectively.
4.
Compute net benefit from each of the three alternatives.
4.
Answer to Problem 20BEA
Net benefit from alternatives A, B, and C is $5,000,000, $3,500,000, and $0 respectively.
Explanation of Solution
Net benefit from a risk response alternative can be computed by using the following formula:
Computation of net benefit from alternative A:
Substitute $8,000,000 for response benefit and $3,000,000 for response cost in the above formula:
Computation of net benefit from alternative B:
Substitute $16,500,000 for response benefit and $13,000,000 for response cost in the above formula:
Computation of net benefit from alternative C:
Substitute $0 for response benefit and $0 for response cost in the above formula:
Therefore, net benefit from alternatives A, B, and C is $5,000,000, $3,500,000, and $0 respectively.
5.
Identify the alternative which would be adopted by the company.
5.
Explanation of Solution
Alternative A would be chosen by the company since; net benefit is highest in case of alternative A.
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Chapter 13 Solutions
Managerial Accounting: The Cornerstone of Business Decision-Making
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