Deck 7: Earnings Management

Question 1

Which of the following has NOT been found to be a measure of a non-GAAP financial metric?

A) Earnings before depreciation and amortization
B) Operating income before certain non-recurring expense or revenue items
C) EBITDA
D) GAAP earnings

Answer 1

A

Question 2

Needles suggests that making judgments about what earnings management is becomes difficult because:

A) It depends on management's intentions
B) There is no clear limit beyond which a choice is clearly unethical
C) A perfectly routine accounting estimate may be illegal and unethical
D) All of the above

Answer 2

B

Question 3

If a company is managing its earnings, which of the ethical theories are they most likely following?

A) Rights
B) Fairness
C) Egoism
D) Virtue

Answer 3

C

Question 4

Which of the following author(s) define(s) earnings management as "reasonable and legal management decision making and reporting intended to achieve stable and predictable financial results?"

A) Dechow and Skinner
B) Healy and Wahlen
C) Schipper
D) Thomas E. McKee

Question 5

Which of the following authors(s) link earnings management to choices made in determining earnings that may comprise aggressive, but acceptable, accounting estimates and judgments, as compared to fraudulent practices that are clearly intended to deceive others?

A) Dechow and Skinner
B) Healy and Wahlen
C) Schipper
D) Thomas E. McKee

Question 6

Which technique was used by both WorldCom and Waste Management to manage earnings?

A) Manipulating asset net valuation amounts to minimize operating expenses for a period
B) Accelerating the recording of revenue into an earlier period
C) Delaying needed repairs to a later period
D) All of the above were used

Question 7

Which of the following is NOT a motivation to manage earnings?

A) Companies try to meet or beat Wall Street earnings projections in order to grow market capitalization and increase the value of stock options
B) Avoid the consequences of violating debt covenants
C) To smooth net income over time
D) To maximize employee bonuses

Question 8

Who linked earnings management to an excessive zeal to project smoother earnings from year to year that casts a pall over the quality of the underlying numbers?

A) Warren Buffet
B) Arthur Levitt
C) Thomas E. McKee
D) Lynn Turner

Question 9

Each of the following is a finding of a survey of CFOs about their perceptions of earnings quality except:

A) CFOs believe that earnings are high quality when they are sustainable and backed by actual cash flows
B) CFOs believe that earnings are high quality when they make consistent reporting choices over time
C) CFOs believe key elements of earnings quality are transparency and predictability
D) CFOs estimate that income increasing and income decreasing devices to manage earnings show a 50:50 split

Question 10

Which of the following is NOT considered "earnings management?"

A) "Earnings management" is done to project smoother earnings from year to year
B) Management emphasizes achieving long-term results to meet financial goals
C) Management uses "cookie-jar reserves each year"
D) Executives manipulate the earnings in order to match their predetermined target

Question 11

Which of the following author(s) emphasize(s) a "purposeful intervention in the external reporting process, with the intent of obtaining some private gain"?

A) Dechow and Skinner
B) Healy and Wahlen
C) Schipper
D) Thomas E. McKee

Question 12

In surveys of managers, which technique to manage earnings was considered most acceptable?

A) Changing inventory valuation in order to influence earnings
B) Accounting manipulation
C) Manipulating operating decisions
D) Establishing cookie jar reserves

Question 13

Motivations to smooth net income over time include each of the following except:

A) Maximize bonuses and stock option values
B) Steady increase in earnings each year
C) Minimize overall taxes
D) Make it appear managers are doing better than they really are

Question 14

Which of the following authors(s) focus(es) on "management's intent to deceive the stakeholders by using accounting devices to positively influence reported earnings?"

A) Dechow and Skinner
B) Healy and Wahlen
C) Schipper
D) Thomas E. McKee

Question 15

An unusual aspect of the Green Mountain case is it included:

A) Conference calls that provided earnings guidance to shareholders and analysts were used to mask a financial fraud
B) Desire to meet or beat analysts' earnings expectations led to manipulation of receivables balances
C) Company violated the Sarbanes-Oxley Act
D) PricewaterhouseCoopers knew about inflated inventory values

Question 16

Who distinguished between earnings manipulation and earnings management?

A) Hopwood et al.
B) Thomas E. McKee
C) Arthur Levitt
D) Belverd Needles

Question 17

What is the SEC's position on companies that communicate with investors on social media?

A) It is illegal to do so
B) It is legal so long as companies inform investors which outlets they intend to use
C) It is legal so long as the postings are restricted to Facebook
D) There are no limitations on companies communicating through social media

Question 18

One result of earnings management is:

A) It brings into question the quality of earnings
B) It uses a non-GAAP financial measure to manipulate earnings
C) EBITDA does not reflect GAAP earnings
D) It improves shareholder returns over time

Question 19

Accruals that are based on estimated changes in fundamental economic performance of the firm are:

A) Discretionary accruals
B) Nondiscretionary accrual
C) Operating accruals
D) Cookie jar accruals

Question 20

A common method used to smooth net income over time is:

A) Accelerate revenue into earlier periods
B) Delay expenses into later periods
C) Using accrual of operating expenses and future adjustments
D) Using nonrecurring items to increase earnings in one year and reduce it later on

Question 21

Accruals are potentially troublesome because:

A) They can lead to giving an unmodified audit opinion when it should have been modified
B) They provide an opportunity to manage earnings through aggressive or more conservative estimations
C) They always lead to fraud in financial statements
D) They provide an opportunity to shift debt off the books by setting up an SPE

Question 22

The main difference between a discretionary and nondiscretionary accrual is:

A) Discretionary accruals are items that management has full control over
B) Discretionary accruals are based on changes in the fundamental performance of the firm
C) Discretionary accruals arise from transactions considered normal for the firm
D) Discretionary accruals always lead to an increase in earnings

Question 23

Which of the following was not a technique used by Enron to manage earnings?

A) Used reserves to increase earnings when reported amounts were too low
B) Deliberately overstated the allowance for uncollectibles and adjusted it downward in future years
C) Used mark-to-market estimates to inflate earnings in violation of GAAP
D) Selected which operating assets to "sell" to the SPEs, affecting the gain on transfer and earnings effect

Question 24

Which of the following partnerships that Enron created eventually lead to its demise?

A) JEDI
B) Cactus
C) Chewco
D) Ironman

Question 25

Which of the following is NOT a qualitative factor when assessing materiality?

A) A misstatement that changes a loss into income or vice versa
B) The existence of statutory or regulator reporting requirements that affect materiality thresholds
C) The potential effect of the misstatement on trends, especially trends in profitability
D) The use of simplistic numerical thresholds and rules of thumb

Question 26

Inherent risk refers to:

A) The possibility that a material misstatement will occur within the reporting company's accounting information system
B) The possibility that a material misstatement that has occurred will not be detected on a timely basis by the company's control system
C) The possibility that a material misstatement that has occurred will not be caught be the independent auditor's testing
D) The possibility that a material misstatement will occur in the financial statements

Question 27

In the Statement of Financial Accounting Concepts (SFAC) No. 8. SFAC No. 8 the position about materiality is that:

A) It should always be determined only through qualitative evaluations
B) It should always be determined through quantitative evaluations
C) It should always be determined by considering whether the amount affects past financial statements
D) It should be determined by how the magnitude of the item would be viewed by a reasonable person

Question 28

What was the original motivation by FASB on SPEs?

A) To establish a mechanism to encourage companies to invest in needed assets while keeping related debt of its books
B) To keep the large amount of debt off the books
C) To sell non-producing assets to the SPE
D) To select which assets to sell to the SPEs affecting the gain

Question 29

Auditors need to be attuned to the red flags that fraud may exist because:

A) Materiality judgments are based on red flags identifying possible material misstatements
B) Audit opinions must be withdrawn when red flags indicate fraud may exist
C) Overly-aggressive accounting and outright manipulation of earnings may exist
D) All of the above

Question 30

Deloitte suggests the quality of earnings from the audit perspective should consider all of the following except:

A) Consider earnings components in relation to the earnings continuum
B) Consider large variances in an accounting estimates compared with actual determined amounts
C) Understand the sources of earnings
D) Be familiar with press coverage regarding financial performance

Question 31

Which of the following is NOT required of management under Section 302 of the SOX?

A) Review their disclosure controls and procedures quarterly
B) Identify key control exceptions and determine which are internal control deficiencies
C) Assess each internal control deficiency's impact on the audit report
D) Identify and report significant control deficiencies on material weaknesses to the audit committee and independent auditor

Question 32

All of the following are examples of "Boosting Income with One-Time Gains" except:

A) Recording sales that lack economic substance
B) Boosting profits by selling undervalued assets
C) Including investment income or gains as part of revenue
D) Including investment income or gains as a reduction in operating expenses

Question 33

Which of the following was not pointed to by the SEC as a motivation for fraud in the Xerox case?

A) Xerox misled investors by polishing its reputation on Wall Street and to boost the company's stock price
B) Xerox top management overrode the internal control to manipulate earnings
C) Xerox failed to disclose GAAP violations that led to acceleration in the recognition of approximately $3 billion in equipment revenues
D) Xerox recognized a greater amount of revenue on leases in early years than warranted and didn't break out revenues that should have been deferred and recognized in future years

Question 34

Which of the following was not true according to the Enron case?

A) Fastow developed the concept of buying up oil and gas companies to establish SPEs
B) Fastow worked to structure ventures that met the conditions under GAAP to keep the partnership activities off Enron's books and on the separate books of the partnership
C) Fastow created SPEs that borrowed money from banks and transferred it to Enron in a sale of an operating asset no longer need by Enron
D) The SPE created by Fastow enabled Enron to keep debt off its books while benefiting from transfer and use of the cash borrowed by the SPE

Question 35

All of the following are examples of "Recording revenue too soon or of questionable quality" except:

A) Recording sales that lack economic substance
B) Recording revenue when future services remain to be provided
C) Recording revenue before shipment or before the customer's unconditional acceptance
D) Recording revenue even though the customer is not obligated to pay

Question 36

There are several aspects of the Enron fraud that are dealt with directly in SOX further connecting Enron to reform in the accounting profession. Which of the following is true?

A) SOX permitted the provision of internal audit service for audit clients
B) Off-balance-sheet financing activities were prohibited for all companies
C) Related-party transactions require disclosure in the notes
D) Cookie jar reserves must be disclosed in the notes

Question 37

Which of the following earnings management techniques were not used in the Lucent Technologies, Inc.'s case?

A) Shifting current revenue to a later period
B) Boosting income with one-time gains
C) Recording revenue too soon or of questionable quality
D) Shifting current expenses to a later or earlier period

Question 38

The concept that earnings management might align with conservative versus aggressive reporting is known as the:

A) Earnings judgment
B) Earnings accruals
C) Earnings continuum
D) Earnings manipulations

Question 39

"Cookie jar reserves" can best be described as:

A) Buying a lot of chocolate chip cookies, storing them for when you have a hunger attack, and then releasing them into your stomach
B) Overstating or understating allowances and reversing amounts in the future to smooth out net income over time
C) Accelerating the recording of revenues into an earlier year than is warranted
D) Delaying the recording of expenses to a later year to boost income in the current year

Question 40

Which of the following is NOT one of the techniques used by Gemstar TV Guide International in its accounting fraud?

A) Created cookie jar reserves of advertising revenue to smooth net income
B) Engaged in round trip transactions
C) Used channel stuffing to accelerate the recording of revenue into earlier periods
D) Inflated advertising revenue from nonmonetary and barter transactions

Question 41

Kelly and Jordan are writing a term paper together on the concept of "faithful representation" in the financial statements. Kelly is assigned the task of defining it in the context of an amount being an estimate. Which of the following statements should NOT be used by Kelly in her description?

A) Good faith attempt to gather evidence to support the amount
B) Clear disclosure of an amount as an estimate
C) The nature and limitations of the estimating process
D) Error free procedures in selecting and applying an appropriate process for developing the estimate

Question 42

Which of the following was not an accounting issue in the Sunbeam case?

A) Cookie jar reserves
B) Channel stuffing
C) Bill and hold sales
D) Swap transactions

Question 43

The accounting shenanigan used in the Dell Computer case can best be described as:

A) Recording revenue from exclusivity payments too soon or of questionable quality
B) Shifting current revenue from exclusivity payments to a later period
C) Shifting future expenses to the current period as a special charge
D) Shifting current expenses to a later period

Question 44

The best way to characterize the role of Sherron Watkins in the downfall of Enron is:

A) She directed the internal auditors to examine numerous transactions that led to the discovery of the fraud
B) She gave in to the pressure of Andy Fastow to go along with materially misstated financial statements
C) She was sent to jail even though she cooperated with the government in its case against Enron
D) She tried to alert Ken Lay about the accounting scandal at Enron

Question 45

The SEC requires stealth restatements to be:

A) Disclosed only in periodic reports
B) Disclosed only in an 8-K report or amended 10-K/A or 10-Q/A
C) Increased to more 50% of restatements
D) Disclosed in ten business days after determination of need for restatement

Question 46

Which of the following is NOT an earnings management technique?

A) Failing to write down or write off impaired assets
B) Releasing questionable reserves into income
C) Failing to record expenses and related liabilities when future obligations remain
D) Creating an allowance for uncollectible accounts and adjusting it at year end

Question 47

Sarah's concern in the Solutions Network case is:

A) Expenses were delayed at year-end to manage earnings
B) Revenue was recorded at year-end before the agreement with the customer was finalized
C) Revenue was accelerated into an earlier period through channel stuffing
D) Off-balance sheet entities were not disclosed

Question 48

The auditors in the Tier One Bank case were investigated by the SEC because it:

A) Failed to obtain sufficient competent evidential matter to support audit conclusions
B) Failed to exercise the appropriate level of care in its audit
C) Failed to exercise the proper degree of professional skepticism
D) All of the above

Question 49

The SEC's complaint in its case against Allergan included a charge that the company:

A) Used off-balance sheet entities to manipulate earnings
B) Falsified inventory values to inflate earnings
C) Used non-GAAP measures to meet EPS estimates
D) Used EBITDA to obscure reported earnings

Question 50

The main accounting issues in the Nortel Networks case were:

A) Premature revenue recognition and hidden cash reserves
B) Capitalization of operating expenses and hidden cash reserves
C) Premature revenue recognition and off-balance-sheet entities
D) Capitalization of operating expenses and off-balance-sheet entities

Question 51

In the Hertz fraud, the company tried to explain its use of non-GAAP financial measures by:

A) Comparing them to aggressive but ethical measurements
B) Comparing the validity of the amounts to pre-tax GAAP income
C) Having a conference call with financial analysts to explain their position
D) Correcting problems in internal controls

Question 52

Each of the following is a common revenue recognition device to manage earnings except:

A) Multiple deliverables
B) Channel stuffing
C) Buy and hold
D) Round tripping

Question 53

The best definition of a financial restatement is:

A) A company, either voluntarily or under prompting by its auditors or regulators, revises its public financial information that was previously reported
B) A company, either voluntarily or under prompting by its auditors or regulators, revises its public financial information for the current period
C) An adjustment of financial information due to an error correction
D) All are part of the definition

Question 54

The Monsanto case centered around the:

A) Acceleration of revenue due to channel stuffing arrangements
B) Use of cookie jar reserves to manage earnings
C) Improperly accounting for rebates
D) Use of non-GAAP EPS

Question 55

The North Face case deals with materiality and how auditors employ that metric in an audit. The following are all true except:

A) North Face accounted for barter transactions with full normal margin recognized
B) Crawford devised the 1997 barter transaction so that it was just beneath the materiality threshold
C) Crawford followed the GAAP methods that Deloitte suggested
D) Deloitte proposed an adjusting entry for the 1997 barter transaction, but "passed" on it as immaterial

Question 56

Your professor asks you to consider whether earnings management can be justified by arguing that the net benefits of managing earnings exceeds any harms that may occur. The professor is asking you to apply what reasoning methods to make the analysis?

A) Egoism
B) Act utilitarianism
C) Rule utilitarianism
D) Virtue

Question 57

You work for a company that always pushes the envelope with respect to reporting revenues and expenses. You often disagree with the company because its approach to reporting these amounts cannot be justified from a GAAP perspective. You are upset and are considering whether this is a company that has a culture you want to be part of. Which of the following best characterizes the ethical issues of concern?

A) Rights Theory
B) Moral blindness
C) Ethical Dissonance
D) Materiality

Question 58

Debbie and Steve are discussing a lecture given by their ethics professor after class one day. The professor said that misstatements of earnings are always unethical. Debbie agrees with this situation, but Steve does not. What statement might Steve make to best support his point of view?

A) It depends on whether the misstatements were made deliberately
B) It depends on whether a user relied on the financial statements
C) It depends on whether the statements lead to a modified or unmodified opinion
D) All are valid statements for Steve to support his point of view

Question 59

The Blackswan PetFood case deals with:

A) Using non-GAAP measures of earnings
B) Acceptability of recording unpaid severance accruals
C) Using EBITDA to obscure earnings
D) All of the above.

Question 60

Financial shenanigans involving recording revenue too soon includes all of the following except:

A) Recording revenue when future services are still to be provided
B) Recording revenue before shipment of a product
C) Recording revenue after customer acceptance
D) Recording revenue when the customer is not obligated to pay

Question 61

March 26, 2015, A San Francisco federal judge allowed Zynga Inc. shareholders to proceed with their class-action lawsuit alleging the online gaming company failed to disclose slumping revenue growth before its market value declined by several billion dollars in 2012. According to the plaintiffs, Zynga concealed declining user activity, masked how changes in a Facebook platform for its games would affect demand, and inflated its 2012 revenue forecast. The shares fell from a peak of $15.91 on March 2, 2012 to below $3 on July 26, 2012, when Zynga posted disappointing earnings and cut its outlook.
Zynga says it recognizes revenue after it determines that a service has been provided to a player and the collection of fees is "reasonably assured." But determining that a service has been provided seems a little more complicated than it would appear, because Zynga needs to differentiate between the types of goods it sells its players.
Zynga, which makes games like FarmVille and Mafia Wars for social networking platforms like Facebook, classifies the game items it sells to players as either "consumable" or "durable" goods. The former category is for goods that players can immediately use, like energy in the game CityVille; the latter is for goods that players buy and keep for the duration of the game, such as tractors in FarmVille.
The company recognizes revenue for the consumable goods as soon as they are consumed. The durable goods present a problem, however, because things like virtual tractors don't depreciate, but potentially live forever, and the company is obligated to ensure that the virtual game pieces continue to exist in the game world. That's forced Zynga to come up with a system of determining how long that may be.
Discuss the challenges of recognizing revenue for the online products/services Zynga provides to its customers. Draw an analogy between how Zynga should go about recognizing revenue and when gift cards are sold to be used at a later date.

Question 62

Which of the following was NOT one of the schemes used by Beazer Homes to manipulate its earnings?

A) Improper recording of revenue on sale-leaseback transactions
B) Fraudulently increased land inventory expense accounts to reduce earnings
C) Over-reserving of house cost-to-complete expenses to increase reported earnings in earlier periods
D) Recording revenue from roundtrip transactions prematurely

Question 63

The Xerox case deals with accounting for multiple deliverables. Explain what this means in the context of the Xerox fraud.

Question 64

Discuss all the factors an auditor should consider in making a materiality judgment.

Question 65

Assume you are a CPA and the accounting manager of a small privately-owned business that has three co-equal shareowners. Your company receives $1,000 from a cash sale of merchandise taken by the customer. Your boss tells you to recognize only $700 and put the other $300 in reserves. What would you do and say and why? Use ethical reasoning to support your position.

Question 66

Explain what is meant by "quality of earnings" including links to earnings management and audit committee responsibilities in evaluating the quality of earnings?

Question 67

In Chapter 7 we discuss the work of Sam Antar, a convicted felon and former CFO of Crazy Eddie, in helping to analyze and ferret out the fraud at Green Mountain Roasters in September 2012. Today Antar works very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals.
In October 2015, Andy Fastow, also a CFO (at Enron) and convicted felon, spoke at the University of Missouri on "Pride and Repentance: The Enron Story," focusing on his personal shortcomings and similar number-fudging he says is still occurring in companies across the world. Despite the damage he caused, Fastow said he didn't break any rules while at Enron but instead found ways around the rules for his own and the company's benefit.
Do you believe that convicted felons should be allowed to benefit from their work and speeches in a financial or reputational way? Use ethical reasoning to support your answer.

Question 68

What is a financial shenanigan and what is it designed to do? Explain each of the financial shenanigans described by Schilit and provide examples of each.

Question 69

Analyze and discuss when earnings management may be an ethical practice and when it is an unethical practice.

Question 70

Categorize the financial shenanigans in the fraud cases at Gemstar-TV Guide and Lucent.

Question 71

Explain why a company's reported earnings may not necessarily be an objective measure of economic reality. Give examples of when this might occur.