Question 1

The city of Morgantown gave a piece of land to Acme,Inc.so that the company would build its new factory in Morgantown and create many local jobs.One appraiser said the land was worth $500,000,while a second appraiser said the land was worth $520,000.
1.What effect will it have on Acme's earnings per share if it records the land at $500,000 rather than $520,000?
  2.What effect will it have on Acme's total assets if it records the land at $500,000 rather than $520,000?
  3.Name one ratio that will be affected by Acme's choice of value for the land.Will this ratio be higher or lower if Acme records the land at $500,000 rather than $520,000?
4.Explain the relationship between management's choice of recorded value for the land and the company's quality of earnings.

Accepted Answer

The answer of The city of Morgantown gave a piece...

Question 2

The town of Columbia gave a piece of land to Wind Energy,Inc.so that the company would build its new factory in Columbia and create many local jobs.One appraiser said the land was worth $200,000,while a second appraiser said the land was worth $220,000.If Wind Energy,Inc.records the land at $220,000,this accounting choice would be considered ________.

Accepted Answer

Recording the land at $220,000 despite one appraiser suggesting it is worth $200,000 is considered an aggressive accounting choice as it inflates the value of the asset on the balance sheet.

Question 3

What may be the effect on a company's financial statements in the year a company sets up a cookie jar reserve?

Accepted Answer

Setting up a cookie jar reserve typically involves recognizing expenses earlier than necessary, which reduces net income in the period the reserve is established. This action increases liabilities, as the reserve is accounted for as a liability on the balance sheet, leading to net income being too low and total liabilities being too high in that period.

Question 4

Which of the following may indicate a company is setting up a cookie jar reserve this year?

Accepted Answer

Option A indicates that the company is setting up a cookie jar reserve. A larger estimated warranty liability than in prior years could indicate that the company is setting aside more money to fund warranties in the future, even though it may not be necessary. This practice can help the company boost future earnings when it releases money from the reserve. Option B indicates that the company is using less money to fund warranties, which would not be consistent with setting up a cookie jar reserve. Option C relates to cash flow, which does not necessarily indicate a cookie jar reserve. Option D may be an indication of a cookie jar reserve, but its absence does not rule out the possibility that a company is setting up a reserve.

Question 5

A firm with high quality earnings may indicate the firm ________.

Accepted Answer

High quality earnings suggest that a firm recognizes revenue in a timely and appropriate manner, avoiding postponement which could misrepresent financial health.

Question 6

Quality of earnings is considered higher if management depreciates its long-term assets over a longer period than the industry average.

Accepted Answer

Quality of earnings is not necessarily higher if management depreciates its assets over a longer period than the industry average. In fact, this may be an indication of aggressive accounting practices and could result in overstated assets and net income.

Question 7

During the year,Core,Rupt,and Baroque,Inc.had sales revenue of $13,200.For each of the following ranges of estimates provided,indicate which percent is the more conservative choice.
a.Estimated sales returns range from 1 to 2% of total sales
b.Bad debts are expected to be between 1 and 2% of net sales
c.Estimated warranty costs are 1 to 2% of net sales
d.Straight-line depreciation rate could be 10% or 20% for its buildings

Accepted Answer

The answer of During the year,Core,Rupt,and Baroque,Inc.had sales revenue of...

Question 8

Firms that choose larger salvage values for their depreciable assets often have higher quality of earnings.

Accepted Answer

Choosing a larger salvage value for depreciable assets means that the assets will be depreciated over a longer period of time, which results in lower annual depreciation expenses and higher reported earnings. This can result in a lower quality of earnings because it may be seen as artificially inflating earnings by deferring the recognition of expenses.

Question 9

How can you tell if a company is taking big bath charges this year?

Accepted Answer

Comparing several previous years' income statements can reveal any unusual expenses or write-offs, which may indicate a company is taking big bath charges. The other options may not necessarily indicate big bath charges.

Question 10

Firms that recognize revenue early or postpone recognition of expenses often have a lower quality of earnings.

Accepted Answer

Recognizing revenue early or postponing expenses can artificially inflate a company's financial results, making their earnings appear higher than they actually are. This can lead to a lower quality of earnings, as investors may question the sustainability and accuracy of the reported earnings.

Question 11

The quality of earnings is considered to be higher when ________.

Accepted Answer

Management choosing accounting methods that result in conservative earnings is considered to be a higher quality of earnings as it results in a more accurate representation of the company's financial health. It reduces the risk of earnings manipulation and provides more transparency to investors. A, B, and C are all factors that could potentially reduce the quality of earnings.

Question 12

Quality of earnings is considered higher if management ________.

Accepted Answer

The answer of Quality of earnings is considered higher if...

Question 13

Which of the following is considered aggressive accounting?

Accepted Answer

The answer of Which of the following is considered aggressive...

Question 14

Quality of earnings is considered higher if management depreciates its long-term assets over a shorter period than the industry average.

Accepted Answer

The answer of Quality of earnings is considered higher if...

Question 15

Incentive-based compensation plans should offer rewards to management for performance that creates increased shareholder value to help avoid management's incentive to manipulate earnings per share.

Accepted Answer

Incentive-based compensation plans that offer rewards based on the creation of increased shareholder value can help mitigate the incentive for management to manipulate earnings per share, as their focus is on overall company performance rather than just short-term results.

Question 16

$\bold{\text{Team Instructions:}}$ Divide the class into teams of three or four people.Give the students time in class to work with their teammates and put together a final correct copy of the problem.Each team should turn in only one copy of the problem for grading.All team members will receive the same grade.
Acme Enterprise just paid $280,000 to buy ten new company cars for its salespeople to use.Acme expects to use these cars for two or three years and then replace them.
1.If Acme uses the ten cars for three years,it then expects to be able to sell them for $10,000 each.How much depreciation expense will Acme record each year using the straight-line method?
2.If Acme uses the ten cars for only two years,it then expects to be able to sell them for $12,000 each.How much depreciation expense will Acme record each year using the straight-line method?
3.If Acme has 1,000,000 weighted-average shares of common stock outstanding,how much difference will the choice of useful life make in the company's earnings per share?
4.Which useful life would be considered aggressive?
5.Which useful life would improve the quality of Acme's earnings?
6.Explain the relationship between management's choice of accounting method and a company's quality of earnings.

Accepted Answer

The answer of $\bold{\text{Team Instructions:}}$ Divide the class into teams...

Question 17

A firm with low quality earnings may indicate the firm ________.

Accepted Answer

Low quality earnings often result from aggressive accounting practices, such as delaying the recognition of expenses, which can artificially inflate net income.

Question 18

Ken's Candy has been selling to Art's Quik Mart for thirty years.Lately Art's has been paying its bills increasingly slowly.Right now,Ken's Candy has $10,000 in accounts receivable on its books from Art's Quik Mart for candy sold to Art's over the last six months.Art's Quik Mart says it will pay the bill as soon as it can.Ken's Candy is trying to decide whether it should increase its allowance for uncollectible accounts to cover the amount owed by Art's.If Ken's Candy increases the allowance,this accounting choice would be considered ________.

Accepted Answer

Increasing the allowance for uncollectible accounts is a conservative approach as it assumes that Art's Quik Mart may not be able to pay its bills in the future. This approach is cautious and considers the worst-case scenario to ensure that the financial statements accurately reflect the company's financial position.

Question 19

Analyst's emphasis on earnings ________.

Accepted Answer

Analysts' emphasis on earnings may cause companies to report lower quality earnings as they may prioritize short-term financial gains over long-term sustainability.

Question 20

Ken's Candy has been selling to Art's Quik Mart for thirty years.Lately Art's has been paying its bills increasingly slowly.Right now,Ken's Candy has $10,000 in accounts receivable on its books from Art's Quik Mart for candy sold to Art's over the last six months.Art's Quik Mart says it will pay the bill as soon as it can.Ken's Candy is trying to decide whether it should increase its allowance for uncollectible accounts to cover the amount owed by Art's.If Ken's Candy does not increase the allowance,this accounting choice would be considered ________.

Accepted Answer

If Ken's Candy does not increase its allowance for uncollectible accounts, it is taking an aggressive accounting stance. This means that the company is not preparing for the possibility that it may not be able to collect the entire amount owed by Art's Quik Mart, which could lead to a potential financial loss for Ken's Candy in the future. By not increasing the allowance, Ken's Candy is recognizing the full amount of the accounts receivable owed by Art's as revenue, which could inflate its financial statements.

Quiz 11: Quality of Earnings, corporate Governance, and Ifrs