Exam 6: Accounting Quality

Quality accounting information seeks to maximize relevance and economic faithfulness,subject to the constraints of the ____________________ of the measurements.

For each of the following factors,determine if the given change or level of that factor would lead an analyst to believe that managers of a firm are more or less likely to engage in earnings manipulation:                                                                      Earnings Manipulation                                                                      $\text {\underline{More likely/ less likely } }$ 1. Days Sales in Receivable Index increases 2. Gross Margin Index decreases below 1 3. As5et Quality Index increases 4. Depreciation Index decreases to below 1 5. Leverage Index increases

On the income statement,income from discontinued operations is shown: 

An extraordinary gain or loss is unusual in nature,_____________________________________________,and material in amount.

Which of the following is not considered a motive to manage earnings?

Which of the following does not describe an extraordinary gain or loss?

Banks Corp.reported net income of $595,000 in 2012.During 2012 Banks reported a loss of $87,435 from a peripheral activity.The loss was included as part of income from continuing operations.Assuming that the loss is a one-time event and that Banks has an effective tax rate of 35%,calculate Banks' adjusted net income.Show all of your calculations for credit. In addition,discuss why analysts might make an adjustment of this type.

Which of the following items is consistent with earnings being informative about current performance but not informative about future earnings?

The _________________________ is the date on which a firm commits itself to a formal plan to dispose of a business segment.

On July 15,2009 Time Services decided to sell its agricultural business and focus on its landscape equipment business.The sale of the agricultural business qualifies for discontinued operations accounting treatment.On November 11,2009 Time Services signs a firm contract to sell the agricultural business to Acme Inc.on March 10,2010.For each of the situations listed discuss how Time Services would report the discontinued operations in its December 31,2009 income statement.(You may disregard tax issues with respect to the sale.) Situation 1: For the period January 1,2009 to July 15,2009 Time Services reports that the agricultural business lost $3.2M.From July 16,2009 to November 11,2009 Time Services reports that the agricultural business loses an addition $1.4 million dollars.At the end of the 2009 Time estimates that it will lose an additional $800,000 on the sale of the agricultural business when it is finally completed in 2010. Situation 2: For the period January 1,2009 to July 15,2009 Time Services reports that the agricultural business had a profit of $1.5M.From July 16,2009 to November 11th,2009 Time Services reports that the net income from the agricultural business was $600,000 dollars.At the end of the 2009 Time estimates that the sale of the agricultural business will result in a gain of $1.7 million dollars when it is finally completed in 2010. Situation 3: For the period January 1,2009 to July 15,2009 Time Services reports that the agricultural business lost $3.2M.From July 16,2009 to November 11th,2009 Time Services reports that the agricultural business loses an addition $1 million dollars.However,at the end of the 2009 Time estimates that the sale of the agricultural business will result in a gain of $1.3 million dollars when it is finally completed in 2010.

When evaluating the quality of accounting information,an analyst should consider all of the following except:

All of the following are typically recognized as accounting liabilities except:

Many times an analyst will have to make judgments as to whether to include unrealized gains and losses when assessing earnings persistence and predicting future profitability.Discuss the case for and the case against including unrealized gains and losses as part of sustainable earnings when examining earnings persistence and future profitability.

Achieving comparability in financial reporting is important to the analysis of multinational firms.However,the data from the reconciliation of foreign firm's financial statement to U.S.GAAP must be carefully interpreted.What types of things complicate the analysis of multinational firms?

Mattel,Inc.designs,manufactures and markets various toy products worldwide through sales to retailers and directly to consumers.Among the company's many products are Barbie,GI Joe,and American Girls.Below is an income statement for Mattel for years 2002,2001 and 2000.Notes to the financial statements reveal the following information. 1.Discontinued Operations - In 1999 Mattel merged with Learning Company,with Mattel being the surviving company.The Learning Company,which produced consumer software,represented a separate line of business for Mattel.In 2000 Mattel's Board of Directors committed to dispose of the Learning Company and its consumer software operations.In 2000 the Learning Company was reported as a discontinued operation and the company was sold to Gores Technology on October 18,2000. In 2002 Mattel received a contractual payment from Gores Technology based on the sale of assets of Learning Company and other liquidation events. 2.Accounting Change - In 2001 Mattel changed the manner in which it accounted for derivative instruments consistent with the issuance of SFAS No.133 Accounting for Derivative Instruments and hedging Activities.The change resulted in Mattel recording a one-time adjustment of $12 million. 3.Accounting Change - In 2002 the FASB issued SFAS No.142 Goodwill and Other Intangible Assets.The standard requires that management estimate the value of its goodwill and,if necessary,record an impairment charge.Consistent with SFAS No.142 Mattel recorded a one-time adjustment of $252.2 million,net of tax,as the cumulative effect of the change in accounting principle. Mattel, Inc. Selacted Income Statement data Fiscal year end 12/12002 12/31/2001 12/31/2000 (amounts in thousands of dollars) Net sales 44,885,340 34,687,924 54,565,499 Cost of Goods Sold \undereline (2,572,247) Gross profit 2,360,987 2,148,934 1,993,242 Selling and Administrative Expenses (1,602,846) (1,507,793) (1,560,157) Amortization of Goodwill 0 (46,121) (46,561) Non-operating incomelexpense (22,747) (9,878) (8,121) Interest expense Income from Continuing Operations before Income Taxes 621,497 430,010 225,424 Provision for income taxes Income from Continuing Operations 455,042 310,920 170,177 Gain (Loss) from Discontinued Oper., net of tax Income (Loss) before Cumulative Effect of 482,295 310,920 (430,969) Change in Accounting Principles Cumulative Effect of Change in Accounting Principles, net of tax Net Income (Lass) Required: a.Discuss whether or not you would adjust for each of the following items when using earnings to forecast the future profitability of Mattel: (1)Discontinuance of the Consumer Software operations. (2)The change in accounting for derivative instruments. (3)The change in accounting for goodwill and other intangible assets. b.Indicate the adjustment you would make to Mattel's net income for each of the items in part a. c.Prepare a common size income statement for 2002,2001,and 2000 for Mattel. d.Repeat part c after making the income statement adjustments in part b. e.Assess the changes in profitability of Mattel during the three-year period. a.

Healy and Wahlen state that one type of earnings management occurs when managers use judgement in financial reporting to alter financial reports in order to mislead some stakeholder about the economic performance of the company.Earnings management is a consequence of a judgement by management which results in lower economic information content of the financial reports. Discuss five motives that encourage managers to practice earnings management.

Earnings that are high quality would:

On the income statement the disposal of a segment of a business should be shown _________ .

In bankruptcy prediction analysis,a type ____________________ error is classifying a firm as bankrupt and it ultimately survives.

When evaluating the quality of accounting information the user should consider the reasonableness of the ____________________ made in applying GAAP.