Deck 9: Accounting Quality

Question 1

When a company makes a change in an estimate that it has used in its financial statements,it should account for the change by

A) retroactively restating all prior financial statements
B) treat the change as a cumulative effect change in accounting estimate
C) spread the effect of the change over the current and future periods
D) companies are not allowed to make changes to estimates

Answer 1

C

Question 2

On the income statement,income from discontinued operations is shown

A) as an accounting principle change.
B) without any income tax effect.
C) as a separate section of income from continuing operations.
D) net of taxes after income from continuing operations.

Answer 2

D

Question 3

Firms' choices and estimates within U.S.GAAP or IFRS should be determined by all of the following except:

A) firms' underlying economic circumstances.
B) conditions in the company's industry.
C) the company's competitive strategy.
D) accelerated management efforts to meet earnings projections.

Answer 3

D

Question 4

As transitory components become a more important part of a firm's reported earnings,the reported earnings

A) are more quality enhanced.
B) become a more reliable indicator of sustainable cash flows.
C) are a less reliable indicator of sustainable cash flows.
D) are a more reliable indicator of fundamental value.

Question 5

Which one of the following is an example of sustainable earnings?

A) A gain from corporate restructuring.
B) A loss from debt retirement.
C) A settlement paid by the company for a class action suit.
D) Earnings from repeat customers.

Question 6

Under new accounting standards passed in 2006 firms must report changes in accounting principle in the current and prior years as if the new accounting principle had been applied all along.The rationale for this change was

A) using the same accounting principle in current and prior periods enhances the information content of reported earnings in forecasting future earnings.
B) conservatism.
C) comparability.
D) materiality.

Question 7

The assessment of earnings quality is best accomplished through the use of which one of the following?

A) Balance sheet and cash flow statement.
B) Single-step financial statements.
C) Single-step income statement, balance sheet, and cash flow statement.
D) Multi-step income statement, balance sheet, and cash flow statement.

Question 8

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

A) infrequent in occurrence
B) peripheral to the company's core business
C) unusual in nature
D) material in amount

Question 9

The best measure of a firm's sustainable income is

A) net income.
B) income from continuing operations.
C) income before extraordinary items.
D) income before extraordinary item and change in accounting principle.

Question 10

Which of the following items is consistent with earnings being informative about current performance and informing the analyst that level of current earnings are not sustainable?

A) The firm recognizes an unexpected gain
B) The firm recognizes a fair value gain on a financial asset as a result of a favorable move in interest rates.
C) The firm recognizes additional expenses this period due to pre-opening costs associated with new stores.
D) The firm experiences a large jump in sales and earnings as a result of successful research and development of new products.

Question 11

In a restructuring it is possible that managers may use the opportunity to write down assets that do not even relate directly to the restructuring action.Why might a manager decide to write down an asset that is not included in the restructuring action?

A) The manager is practicing conservatism.
B) The write down relieves future periods of depreciation expense, which increases cash flows.
C) Normally the stock market reacts positively to restructuring and the greater the amount the better.
D) The write down relieves future periods of depreciation expense, which increases earnings.

Question 12

Users of financial statements should consider which of the following when evaluating the quality of accounting information?

A) Economic faithfulness of accounting measurements and classifications.
B) Reliability of the measurements.
C) Reasonableness of the estimates made in applying GAAP or IFRS.
D) All of these should be considered.

Question 13

Examples of poor earnings quality that hinder the forecasting of expected future earnings include all of the following except:

A) Earnings dominated by a substantial one-time gains from the sale of real estate tangential to the firm's operations.
B) Reporting a large expense from a warehouse fire that was not covered by insurance.
C) A local government corrects a processing error and a firm receives an unexpected rebate on property taxes previously paid.
D) The company adds equipment that reduces carbon emissions in response to EPA requirements and increases production efficiency.

Question 14

During July 2012 Ralston Company decides to dispose of one of its subsidiaries which qualifies for accounting as a discontinued operation.At the July 2012 measurement date Ralston Company estimates that it will report net losses of $1,500,000 dollars from the measurement date until the disposal date which is expected to be in April 2013.In addition,Ralston estimates that it will lose $300,000 on the sale of the segment.How much gain or loss on discontinued operations will Ralston report in its 2012 income statement (net of income taxes)?

A) $1,500,000 loss
B) $0
C) $1,800,000 loss
D) $300,000 loss

Question 15

All of the following are true regarding a high quality balance sheet except:

A) It should portray the economic resources that can be reasonably expected to generate future economic benefits.
B) It should provide a complete and fair portrayal of all of the firm's obligations at a point in time, including the present value of long-term liabilities for future payments.
C) It should minimize measurement error and bias.
D) It should be optimistic in terms of accounting numbers.

Question 16

During July 2012 Ralston Company decides to dispose of one of its subsidiaries which qualifies for accounting as a discontinued operation.At the July 2012 measurement date Ralston Company estimates that it will report net income of $200,000 dollars from the measurement date until the disposal date which is expected to be in April 2013.In addition,Ralston estimates that it will lose $300,000 on the sale of the segment.How much gain or loss on discontinued operations will Ralston report in its 2012 income statement (net of income taxes)?

A) $200,000 gain
B) $0
C) $100,000 loss
D) $300,000 loss

Question 17

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

A) The firm recognizes an unexpected gain
B) The firm recognizes a fair value gain on a financial asset as a result of a favorable move in interest rates.
C) The firm recognizes additional expenses this period due to pre-opening costs associated with new stores.
D) The firm experiences a large jump in sales and earnings as a result of successful research and development of new products.

Question 18

Income or loss from discontinued operations would best be regarded by an analyst as:

A) sustainable earnings.
B) impairments.
C) transitory earnings.
D) permanent earnings.

Question 19

Which of the following items is consistent with earnings being informative about current performance and informing the analyst that level of current earnings is sustainable?

A) The firm recognizes an unexpected gain
B) The firm recognizes a fair value gain on a financial asset as a result of a favorable move in interest rates.
C) The firm recognizes additional expenses this period due to pre-opening costs associated with new stores.
D) The firm experiences a large jump in sales and earnings as a result of successful research and development of new products.

Question 20

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

A) The firm recognizes an unexpected gain
B) The firm recognizes a fair value gain on a financial asset as a result of a favorable move in interest rates.
C) The firm recognizes additional expenses this period due to pre-opening costs associated with new stores.
D) The firm experiences a large jump in sales and earnings as a result of successful research and development of new products.

Question 21

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

Question 22

A ____________________ of operations differs from a discontinuation of operations because the firm continues to operate in the business segment.

Question 23

When evaluating the quality of accounting information the user should consider the ____________________ of the measurements made.

Question 24

Earnings that are high quality would

A) be informative about current performance and provide information about the long-run sustainability of profits.
B) be informative about past performance and provide information about the long-run sustainability of profits.
C) be informative about current performance and provide information about the long-run sustainability of assets.
D) be informative about past performance and provide information about the long-run sustainability of assets and liabilities.

Question 25

Accounting information should provide a fair and complete representation about a number of a firm's characteristics.Which of the following is not one of those characteristics?

A) risk
B) position
C) performance
D) conservatism

Question 26

One definition of earnings management is that it occurs when managers use

A) judgment in financial reporting to alter financial reports to mislead stakeholder.
B) an accounting method that is inconsistent with other industry members.
C) more conservative accounting estimates than other companies.
D) pro forma accounting results as opposed to GAAP results.

Question 27

A ______________________________ is accounted for by spreading the effect of the prior year's misstatement over the current and future periods.

Question 28

Accounting information should provide relevant information to forecast the firm's expected future earnings and _________________________.

Question 29

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

A) disposal date
B) measurement date
C) commitment date
D) sale date

Question 30

Gains and losses differ from revenues and expenses in that they are produced by ____________________ activities.

Question 31

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

A) To create optimal manager compensation payments.
B) To create optimal job security for senior management.
C) To create optimal measures of assets and liabilities for balance sheet purposes.
D) To manage reported earnings in order to reduce industry-specific actions.

Question 32

Which of the following is not a characteristic of an extraordinary item?

A) Unusual in nature
B) Infrequent in occurrence
C) Material in amount
D) Subject to a firm commitment

Question 33

Quality accounting information should be informative as to both the __________________________________________________ of the current period's earnings and the long-run sustainability of profits.

Question 34

Many times a financial analyst may decide to make adjustments to the financial statements in order to make the statements more useful.Which of the following would not require an adjustment to the financial statement?

A) A company signs a new contract with a customer.
B) A delivery company incurs a loss from disposition of used delivery trucks.
C) A company changes the useful life of its equipment from 5 years to 8 years.
D) A company incurs a charge related restructuring its operations.

Question 35

Firm's choices and estimates within U.S.GAAP should be determined by

A) how the industry operates.
B) the firm's underlying economic circumstances.
C) SEC interpretations regarding specific choices.
D) the firm's auditor.

Question 36

Accounting information should be a fair and complete representation of the firm's economic ____________________,____________________,and ____________________.

Question 37

Gains and losses that appear in Other Comprehensive Income are the result of value changes

A) only in non-current assets and liabilities.
B) in stockholders' equity.
C) driven by difficult measurement issues.
D) that have not been realized in a market transaction.

Question 38

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

Question 39

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

A) reliability of the measurements made
B) adequacy of disclosures
C) comparability of estimates
D) economic faithfulness of the measurements made

Question 40

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

Question 41

Many users of financial statements believe that the quality of accounting information for intangible assets is low because firms seldom report intangible asset resources on the balance sheet.However,from the perspective of accounting quality what are arguments in favor of expensing most intangibles and not recording them on the balance sheet?

Question 42

Earnings are informative if they signal the portion of current period's due to a new product and the additional earnings in the future as a result of the ____________________ of this new earnings stream.

Question 43

The _________________________ is the date of closing the sale,if the firm intends to sell the segment,or the date operations cease,if the firm intends to abandon the segment.

Question 44

U.S.GAAP requires that changes in estimates be accounted for by recognizing the effect ________________________________________ period(s).

Question 45

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.

Question 46

Penny Corp.manufactures telecommunication equipment and has been profitable each year for the past ten years.During 2010 the company saw its core market decline sharply when a competitor introduced a significant new product technology.In response to the decline in business Penny Corp.announced a major restructuring of its operations.The restructuring plan which would be implemented in 2010 would involve the following changes (all of the charges are material):
Penny Corp.has never previously restructured its operations and believes that it can return to profitability within two years based on its current research and development activity.
Required:
1.Discuss whether or not you would eliminate the restructuring charge from the 2010 income statement of Penny Corp.when using earnings to forecast future profitability.
2.Penny Corp.'s restructuring charges cover a wide range of different cost categories,identify those that entail a cash payment and those that do not require a cash payment.For those charges not requiring a cash payment how would they be treated in the Statement of Cash Flows?

Question 47

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 four reasons that discourage managers from practicing earnings management.

Question 48

On September 1,2012,Ramos Inc.approved a plan to dispose of a segment of its business.Ramos expected that the sale would occur on March 31,2013,at an estimated gain of $350,000.The segment had actual and estimated operating profits (losses as follows):
Assume a marginal tax rate of 30%.
Required:
In its 2012 income statement,what should Ramos report as profit or loss from discontinued operations (net of tax effects)?

Question 49

Some firms attempt to maximize the amount of restructuring charge in a particular year,analysts refer to this as the _________________________ approach.

Question 50

____________________ represents the concept of being able to compare financial statement data across years for any particular firm.

Question 51

Under current GAAP unrealized gains and losses from four balance sheet items are reported in ___________________________________________________________________________.

Question 52

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

Question 53

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.

Question 54

First Bank recognized an extraordinary loss from the settlement of a lawsuit with Fifth Street Bank that it had impeded on a processing patent.The extraordinary loss was in the amount of $3,250,000 and First Bank Corporation has an effective tax rate of 35%.First Bank paid the settlement immediately and recognized the tax benefit as a receivable to offset the current period's taxes.
Instructions:
a.Prepare the extraordinary item portion of First Bank Corporation's financial statement.
b.Using the analytical framework discussed in the text and reprinted below show the effect of following event on First Bank Corporation's financial statements.
Analytical Framework:

Question 55

When evaluating the quality of accounting information the user should consider the ____________________ of the firm's disclosures.

Question 56

Creighton Corp.,a textile manufacturer,reported net income of $258,000 in 2012.During 2012 Creighton reported a gain of $29,800 from the sale of three used delivery trucks.The gain was included as part of income from continuing operations.Assuming that the gain is a one-time event and that Creighton has an effective tax rate of 35% calculate Creighton's adjusted net income.Show all of your calculations for credit.
In addition,discuss why analysts might make an adjustment of this type.

Question 57

Banks Corp.reported net income of $390,000 in 2012.During 2012 Banks reported a loss of $72,000 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.

Question 58

When evaluating the quality of accounting information the user should consider the _____________________________________________ of the measurements made.

Question 59

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

Question 60

A company may try to paint a favorable picture of itself by accelerating the timing of revenues or estimating the collectible amounts too aggressively.In these cases the quality of accounting information declines because it does not represent the company's true economic condition and may not be sustainable.List four conditions which might suggest that a company is recognizing revenues too early?

Question 61

Motor Corporation's income statements for the years ended December 31,2012 and 2011 included the following information before adjustments:
On January 1,2012,Motor Corporation agreed to sell the assets and product line of one of its operating divisions for $1,600,000.The sale was consummated on December 31,2012,and it resulted in a gain on disposition of $450,000.This division's pre-tax net losses were $320,000 in 2012 an $250,000 in 2011.The income tax rate for both years was 30%.
Required:
Starting with operating income (before tax),prepare revised comparative income statements for 2012 and 2011 showing appropriate details for gain (loss)from discontinued operations.

Question 62

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.

Question 63

On November 15,2012,Jacobs Co.sold a segment of its business for $2,750,000.The net book value of the segment at the time of its disposal was $3,000,000.Jacobs had pretax operating income of $1,750,000 for 2012 which included $380,000 earned by the discontinued segment prior to its disposal.Assume Jacobs' tax rate is 30%.
Required:
Prepare a partial income statement for Jacobs Co.beginning with pretax income from continuing operations.

Question 64

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.
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: