Exam 6: Earnings Management

A Company showed a large restructuring charge on its income statement in 2011 and has experienced a constantly rising earnings trend since that time. This would most nearly represent an example of

Most companies that engage in earnings management typically do not go beyond which of the following activities on the earnings management continuum?

Which of the following is typically associated with cookie jar reserves?

Which of the following organizations has recommended that entities provide a reconciliation to GAAP net income whenever reporting proforma numbers?

Excluding some revenues, expenses, gains, losses from the earnings figure calculated using generally accepted accounting principles is an example of

You are auditing a company whose management has intentionally made adjustments to various financial statement items that are not in accordance with generally accepted accounting principles. This behavior has occurred over a number of accounting periods. None of the individual adjustments by itself is material and the aggregate effect on the financial statements taken as a whole is immaterial. Top management of the client are aware of these misstatements and consider them part of their strategic management of earnings. Explain how you as the independent auditor should respond to this situation.

Net income is a key number for shareholders, creditors, and analysts alike. Indeed, analysts' projections of net income for a company are viewed as a standard a company must achieve for a period of time. Failure to achieve this standard can have devastating effects on a company's stock price and its management. The importance of net income in the eyes of analysts and others can tempt managers to take steps to ensure that the appropriate level of net income is achieved. The process of manipulated net income to achieve a desired level of earnings is referred to as earnings management. Required: List and explain the economic motivations for earnings management.

Managers of many companies frequently provide a pro forma earnings amount in conjunction with their annual or quarterly earnings calculated in accordance with GAAP. Managers claim that pro forma earnings numbers more fairly reflect a company's performance. Required:

One of the five techniques of earnings management identified by the Securities and Exchange Commission relates to materiality. Independent auditors have traditionally used arbitrary quantitative benchmarks to define how large an amount must be to be considered material. During the course of auditing the financial statements of a company, an auditor finds some misstatements in the client's financial statements. When combined, the misstatements, result in a 4% overstatement of net income and a $.02 (4%) overstatement of earnings per share. The auditor's materiality threshold is 5%, that is, an item in the financial statements must be misstated by more than 5% to be considered a material deviation from generally accepted accounting principles. On the basis of the established materiality threshold, the auditor concludes that the deviation from GAAP is immaterial and the accounting is permissible. Define the term "materiality" and explain whether the auditor is justified in the conclusion that the accounting proposed by the client is permissible.

Several catastrophic accounting failures have occurred over the last few years. Although the details of each failure is different, each case stems from attempts to manage earnings and thus all of these failures have common elements. One of the elements identified in these earnings management meltdowns is the auditor's calculated risk. Explain what is meant by the term "the auditor's calculated risk".

Which of the following is true?

The following summarized information is available for Central Plains Company at December 31 of the current year: The debt of Central Plains has a before-tax cost rate of 11.5%, preferred stock has a cost of 12.1%, and common equity has a cost of 14.2%. The tax rate for Central Plains is 34%. Calculate the weighted average cost of capital for Central Plains at December 31 of the current year.

Which of the following items of the earnings management continuum is in the correct order?

Which of the following is true regarding the weighted-average cost of capital?

The Securities and Exchange Commission (SEC) has the right granted to it by Congress to issue accounting standards. The Commission has exercised this right on a relatively infrequent basis. The SEC is not a passive observer to the financial accounting standard setting process, however. Explain the general mission of the SEC and how the SEC fulfills its mission as regards financial reporting specifically.

The practice of carefully timing the recognition of revenues and expenses to even out the amount of reported earnings from one year to the next is called

Research has shown that numerous companies manage their earnings. A variety of earnings management techniques are available ranging from income smoothing to outright fraud. Define income smoothing and explain how it is implemented.

Recent accounting scandals suggest the need for care on the part of an independent auditor in accepting new clients. The independent auditor needs to know both the business of and the personnel employed by a prospective client. All other control procedures are fruitless if a CPA chooses to serve an undesirable client. The damage suffered as a result of associating with an undesirable client can be irreparable. Discuss some key issues an independent auditor should consider in the client acceptance decision.

Recent accounting scandals have raised concerns over the quality and transparency of financial accounting and reporting in the United States. Critics of what is termed the "rules-based" system currently used in the U.S. cite the increasingly detailed and complex nature of rule-driven accounting pronouncements. These critics suggest that the United States should adopt a principles-based system similar to that of the International Accounting Standards Board. Explain what is meant by a principles-based system and the advantages and disadvantages of such a system.

Which of the following services offered by investment firms have some states declared to be incompatible with generating forecasts of company earnings?