Exam 6: Earnings Management

Statement of Financial Accounting Concepts No. 1, "Objectives of Financial Reporting by Business Enterprises," identifies investors and creditors as the primary users of financial reporting information. Investors in public companies express their opinions about an entities equity securities through organized exchanges such as the New York Stock Exchange. Given that investors represent one of the two primary groups to which financial reporting is directed, accountants and auditors preparing and opining on, respectively, the financial statements of public companies should be aware of the effects of the quality of financial reporting on stock prices. Required: Identify four major periods of decline in worldwide stock prices for the years 1997 through 2002 and discuss the role (if any ) of financial reporting in these declines.

The existence of earnings management techniques does not justify their use. Some would say that any form of earnings management is unethical. Others would say that some amount of earnings management within certain bounds is necessary to survival in the modern world. Required: Is earnings management ethical?

Deferring the recognition of revenue for which the earnings process is complete is an example of

Which of the following is the SEC authorized by Congress to do?

The term "earnings quality" refers to the ability of reported earnings to predict an entity's future earnings. To enhance predictability, financial analysts attempt to distinguish between a company's transitory earnings (transactions or events not likely to occur in the future) and its permanent earnings. It is tempting to assume that transitory earnings are represented primarily by discontinued operations and extraordinary items. All items of revenue and expense included in operating income may not be permanent, however. Restructuring costs often are included in determining operating income, yet may or may not continue in the future. Required: Do you think restructuring costs represent transitory earnings or permanent earnings? Explain.

Which of the following typically is not associated with a change in estimate for accounting purposes?

The cost of capital is the cost a company bears to obtain external financing. A company's cost of capital is critical because it determines which long-term projects are profitable for the entity to undertake. The higher the cost to obtain funds, the fewer the long-term projects are profitable for a company to pursue. Required: Explain the role of financial statements generally and the roles of the FASB, the AICPA, the SEC, and the IASB in lowering the cost of capital.

Earnings management through strategic matching is best exemplified by

Which of the following is true about a pro forma earnings number?

The following summarized information is available for Essex Company at December 31 of the current year: The debt of Essex has a before-tax cost rate of 12%, preferred stock has a cost of 12.3%, and common equity has a cost of 14.6%. The tax rate for Essex is 34%. Calculate the weighted average cost of capital for Essex at December 31 of the current year.

Which of the following accounts would not be affected if a company failed to report returns of merchandise sold?

Which of the following typically involves the use of non-GAAP accounting?

The cost of capital is defined as the

Earnings management can range from methods that suggest astute management to outright fraud. Required:

Excessive earnings management typically begins as a result of

Which of the following is incorrect?

Internal earnings targets represent an important tool in motivating managers to increase sales efforts, control costs, and use resources more efficiently. Such internal targets also can cause managers to resort to extreme measures in order to meet goals established by upper management. Earnings management often appears in a variety of forms as a means of reaching these internal goals. Earnings management also is associated with earnings-based internal bonus plans which are also a form of internal target. Explain how earnings management is related to earnings-based internal bonus plans and how managers behave in response to such plans.

Which of the following is true?

"Purchased in-process research and development" is typically associated with

WM is a waste disposal company. Explain the effect the following actions of the management of WM Company might have in managing earnings: