Deck 6: Earnings Management

Question 1

Excessive earnings management typically begins as a result of

A) a regulatory investigation.
B) pressure to meet the expectations of stakeholders.
C) a downturn in business.
D) a violation of generally accepted accounting principles.

Answer 1

C

Question 2

Which of the following is true?

A) Cash flow data is superior to earnings under the accrual basis in predicting long-term performance of an entity.
B) Earnings under the accrual basis is superior to cash flow data in predicting short-term performance of an entity.
C) Earnings under the accrual basis is superior to cash flow data in predicting long-term performance of an entity.
D) Cash flow data is superior to earnings under the accrual basis in predicting both short- and long-term performance of an entity.

Answer 2

C

Question 3

The GAAP Oval best represents the

A) fact that only one true earnings number exists.
B) flexibility managers have within GAAP to report one earnings number from among many possibilities.
C) philosophy that earnings management within limits is ethical.
D) fact that GAAP is not subject to interpretation.

Answer 3

B

Question 4

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

A) "big bath" accounting.
B) a "cookie jar" reserve.
C) a change in an accounting estimate.
D) strategic matching.

Question 5

Which of the following earnings management techniques is frequently associated with start-up companies?

A) Recording immaterial adjustments that cause earnings to meet analysts' expectations.
B) Recording extremely high warranty expense when earnings are high.
C) Recognizing revenue when a contract is signed and before goods are delivered or services are provided.
D) Expensing purchased in-process research and development.

Question 6

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

A) creative acquisition accounting.
B) cookie jar reserves.
C) proforma earnings amounts.
D) big bath accounting.

Question 7

Which of the following is typically associated with cookie jar reserves?

A) Purchased in-process research and development
B) Recognizing very high bad debt expense when earnings are high
C) Recognizing revenue when a contract is signed prior to delivery of goods or performance of services
D) Proforma earnings

Question 8

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

A) Strategic matching
B) A change in accounting estimate that is fully disclosed
C) Proforma earnings
D) A change in accounting principle that is fully disclosed

Question 9

Which of the following organizations has recommended that entities provide a reconciliation to GAAP net income whenever reporting proforma numbers?

A) Auditing Standards Board
B) Financial Executives International
C) Financial Accounting Standards Board
D) Accounting Standards Executive Committee

Question 10

Most companies that engage in earnings management typically do NOT go beyond which of the following activities on the earnings management continuum?

A) Strategic matching
B) Change in methods or estimates with full disclosure
C) Change in methods or estimates with little or no disclosure
D) Non-GAAP accounting

Question 11

Earnings management through strategic matching is best exemplified by

A) changing the useful life of a depreciable asset.
B) timing transactions such that large one-time gains and losses occur in the same quarter.
C) changing the interest rate used in accounting for leases without describing the change in the notes to the financial statements.
D) capitalizing as assets expenditures that have no future economic benefit.

Question 12

Excluding some revenues,expenses,gains,losses from the earnings figure calculated using generally accepted accounting principles is an example of

A) income smoothing.
B) "big bath" accounting.
C) a "cookie jar" reserve.
D) proforma earnings.

Question 13

A Company showed a large restructuring charge on its income statement in 2014 and has experienced a constantly rising earnings trend since that time.This would most nearly represent an example of

A) cookie jar reserves.
B) big bath accounting.
C) creative acquisition accounting.
D) using immaterial transactions to increase reported earnings to meet analysts' expectations.

Question 14

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

A) Return on pension fund
B) Useful life of a depreciable asset
C) Bad debt expense
D) Change in calculating depreciation from straight-line to sum-of-the-years'-digit

Question 15

The cost of capital is defined as the

A) simple average of the interest rates of all debt outstanding.
B) simple average of the cost of debt and equity.
C) weighted average of the interest rates of all debt outstanding.
D) weighted average of the cost of debt and equity.

Question 16

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

A) Sales returns
B) Sales allowances
C) Cost of goods sold
D) Inventory

Question 17

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

A) Only III
B) I and III
C) I and II
D) I,II,and III

Question 18

Which of the following regarding the weighted-average cost of capital is true?

A) The tax effect of preferred stock dividends should be included in the calculation of weighted-average cost of capital.
B) The tax effect of common stock dividends should be included in the calculation of weighted-average cost of capital.
C) The tax effect of debt should be included in the calculation of the weighted-average cost of capital.
D) Taxes do not affect the weighted-average cost of capital.

Question 19

Recording as an asset expenditures that have no future economic benefit is an example of

A) strategic matching.
B) change in methods or estimates with full disclosure.
C) a fictitious transaction.
D) non-GAAP accounting.

Question 20

Which of the following items of the earnings management continuum is in the correct order?

A) Strategic matching,change in methods or estimates with full disclosure,non-GAAP accounting
B) Change in methods or estimates with little or no disclosure,non-GAAP accounting,fictitious transactions
C) Strategic matching,change in methods or estimates with little of no disclosure,fictitious transactions
D) Change in methods or estimates with full disclosure,non-GAAP accounting,fictitious transactions

Question 21

Managers of many companies frequently provide a pro forma earnings amount in conjunction with their annual or quarterly earnings calculated in accordance with GAAP.Managers claim that pro forma earnings numbers more fairly reflect a company's performance.
Required:

Question 22

The following summarized information is available for Saunders Company at December 31 of the current year:
The debt of Saunders 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 Saunders is 34%.
Calculate the weighted average cost of capital for Saunders at December 31 of the current year.

Question 23

Which of the following is NOT correct?

A) The after-tax cost of debt for a firm with losses is equal to the interest rate on the debt.
B) Firms always pay dividends on their common stock issues because of the ease with which common shareholders can assume control of the firm.
C) Flotation costs for preferred stock are higher than for debt.
D) Most debt is placed privately and thus there is no flotation cost.

Question 24

Recognizing more bad debt expense in a year than is necessary in order to have flexibility in recognizing bad debt expense in a future year is an example of

A) a big bath charge.
B) creative acquisition accounting.
C) a cookie jar reserve.
D) premature recognition of revenue.

Question 25

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

A) A pro forma earnings number is in total conformity with GAAP.
B) A pro forma earnings number is a forecast of earnings in future periods.
C) Reporting pro forma earnings by companies subject to SEC regulation is illegal.
D) A pro forma earnings number is regular GAAP earnings with certain exclusions.

Question 26

Which of the following is true?

A) Companies can raise common equity only by issuing new shares of common stock.
B) There is no opportunity cost associated with use of retained earnings as a source of common equity.
C) Most large mature firms issue new shares of common stock on a regular basis.
D) Companies can raise common equity by issuing new shares of common stock and through retained earnings.

Question 27

Which of the following services offered by investment firms have some states declared to be incompatible with generating forecasts of company earnings?

A) Only 3
B) Only 4
C) 3 and 4
D) 1,2,3,and 4

Question 28

Which of the following is NOT a function of a financial analyst?

A) Providing buy recommendations on a company's stock
B) Providing sell recommendations on a company's stock
C) Generating forecasts of company earnings
D) Serving as an investment banker for a company for which the analyst is providing research coverage

Question 29

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

Question 30

Which of the following is true regarding the weighted-average cost of capital?

A) The book value of the components of capital should always be used to calculate the weighted-average cost of capital.
B) A company may have two weighted-average costs of capital if the firm's capital structure is so large that new common stock must be sold.
C) The cost of common equity is lower than the cost of retained earnings.
D) The cost of preferred stock is adjusted for the tax deduction associated with preferred dividends.

Question 31

The following summarized information is available for Eastern Valley Company at December 31 of the current year:
The debt of Eastern Valley has a before-tax cost rate of 11.5%,preferred stock has a cost of 12.1%,and common equity has a cost of 14.2%.The tax rate for Eastern Valley is 34%.
Calculate the weighted average cost of capital for Eastern Valley at December 31 of the current year.

Question 32

The practice of carefully timing the recognition of revenues and expenses to even out the amount of reported earnings from one year to the next is called

A) revenue recognition.
B) income smoothing.
C) restructuring.
D) accrual-basis accounting.