Apply your critical-thinking ability to the knowledge you’ve gained. These cases will provide you an opportunity to develop your research, analysis, judgement and communication skills. You also will work with other students, integrate what you’ve learned, apply it in real world situations, and consider its global and ethical ramifications. This practice will broaden your knowledge and further develop your decision-making abilities.
Judgement case 4-1 (earnings quality) * LO2 LO3
The financial community in the United States has become increasingly concerned with the quality of reported company earnings.
REQUIRED: 1. Define earnings quality. 2. Explain the distinction between permanent and transitory earnings as it
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Judgement case 4-3 (earnings management) * LO2 LO3
Companies often are under pressure to meet or beat Wall Street earnings projections in order to increase stock prices and also to increase the value of stock options. Some resort to earnings management practices to artificially create desired results.
Required:
Is earnings management always intend to produce higher income? Explain.
No, for it doesn’t reflect the true income for it is understated during good years and polishes the result in bad years. Therefore it doesn’t show the proper deduction or addition to some item, in the long run the number of accumulated deficiencies might hard to be fixed or subsidies. In that occurrence the earnings or profit might be off-set to this unrealized loss and might result to higher loss.
Judgement case 4-9 (income statement presentation) * LO2 through LO6
Each of the following situations occurred during 2011 for one of your audit clients: 1. The written-off of inventory due to obsolescence. 2. Discovery that the depreciation expenses were omitted by accident from 2010’s income statement. 3. The useful lives of all machinery were changed from eight to five years. 4. The depreciation method used for all equipment was changed from the declining balance to the straight line method. 5. Ten million dollars face value of bonds payable was repurchased (paid off) prior to maturity resulting in a material loss of
A prior period adjustment is a correction, for an accounting error, on the financial statements of a prior year. ASC 250-10-50-7 states that “when financial statements are restated to correct an error, the entity shall disclose that its previously issued financial statements have been restated, along with a description of the nature of the error. The entity also shall disclose …the cumulative effect of the change on retained earnings or other appropriate components of equity or net assets in the statement of financial position.” The adjustment to the estimate is not a correction due to an error. Therefore, it should not affect or restate retained earnings or liabilities recorded in prior periods
Note 2 (pg. 17) states that in 1984 Harnischfeger changed their depreciation method that was being used to expense their plants, machinery and equipment from the direct method to the straight-line method for financial reporting purposes. An adjustment of the residual values on certain machinery and equipment was made.
25-7 If a loss cannot be accrued in the period when ti is probable that an asset had been impaired or a liability had been incurred because the amount of loss cannot be reasonable estimated, the loss shall be charged to the income of the period in which the loss can be reasonably estimated and shall not be charged retroactively to an earlier period. All estimated losses for loss contingencies shall be charged to income rather than charging some to income and others to retained earnings as prior period adjustments.”
Understandably, there are a variety of ways in which a company can manage their earnings, and if accomplished successfully, the results can be highly profitable. Not all techniques are fraudulent, as effective earnings management is considered good for business and shareholders. Income smoothing is a specific example of permissible earnings management that involves controlling fluctuations in net income to make earnings less variable over a given period of time (Goel & Thakor, 2003). Smoothing is acceptable as long as it adheres to the restrictions of U.S. GAAP, which maintains that all revenues and expenses are accounted for in a defined fashion. There are a lot of incentives in figuring how to effectively smooth income, as substantial value can be created through the successful arrangement of financial transactions. Management is able to make more intelligent decisions with regards to the future of the firm if the earnings are able to match the forecasts. One instance this is seen is when management is faced with the decision to smooth total income or
Such an intense focus has been placed on quarterly earnings as an indication of a company’s success by everyone from analysts to executives that ethics have for the most part been thrown out the window, sacrificed to the all important number, i.e. earnings per share. This is the theory in Alex Berenson’s book “The Number: How the Drive for Quarterly Earnings Corrupted Wall Street and Corporate America.” This number has become part of a game to be played, a figure to be manipulated – beat the number and Wall Street all but throws a parade, miss it and a company’s stock may be abandoned. Take into account the incentives that executives have to beat the number and one can find plenty of reasons to manage earnings.
-In 1984, there was a switch from accelerated to straight line depreciation retroactively. Because of this, the depreciation expense decreased.
For example the extra charge for maintenance accumulated from last year and for this year should be equally divided and not charged to the first quarter only. Similarly, cost of relocating the Southern Paper Sioux Springs office that has been charged to the first quarter, had been the expenditure incurred last year. It should not have been included in the first quarter. No doubt these are good accounting practices but nevertheless reverting the charges to their respective results would not compromise GAAP practice. Unrealized income would be better off transferred to the next or the last quarter as the income received would not materialize until at the end of the year. Including the dividend from the company's Brazilian unit would not help increase profitability at the end of the year unless the company is assured of its profitability. As of now it needs to balance its accounts before it can estimate correct profit level at the end of the year. With regard to the obsolete inventories, there is no alternative course of action but to write-off from this
In order to assess whether the accounting profit is a measure of the true profit it must first
Depreciation method was changed to straight line method from accelerated method. This policy change increased the income of year 1984 by $ 11 Million.
Baruch Lev and Feng Gu authors of “The End of Accounting and The Path Forward for Investors and Managers” indicate that over the past 110 years, the structure and content of financial reports has not changed, and that the role that these reports play in influencing the decisions of investors has greatly diminished. Lev and Gu make a case that non-transaction events that are not captured by the financial reports such as those disclosed through 8-k filings with the Securities and Exchange Commission (“SEC”) have a greater impact on stock prices, and thus more useful to investors. In addition, they suggest that one of reasons for the decline in usefulness of financial reports stems from the increase of estimates that has made its way into these reports (Lev and Gu 2016).
How did he/she handle supervision? Erica readily accepts supervision. She is a quick learner who only needs to see the information or process once.
The most powerful learning experience at this point in my program is the application of critical thinking. People who are analytical thinkers can comprehend and implement critical thinking techniques easy, because they are second nature to them. They will question a question and look at the depth of the situation in a logical way. I possess some analytical traits, but I am not a true analytical person which makes the application of critical thinking a challenge. I will use Elder’s and Paul’s critical thinking guidelines in future courses and in my professional life. I have already started using the guidelines as I prepare to teach certain lessons.
4. A client changed its depreciation method for production equipment from the straight-line method to the units-of-production method based on hours of utilization. The auditor concurs with the change.
Does it matter what your competitors are doing? Step back and consider management’s incentives and choices. What is the motivation to manage earnings?
The companies use earnings management as a strategy by which they can easily control and manipulate their earnings to reach their pre-determined earning target.