Problem Seven: Earnings Persistence/Future Earnings
Consider each of the scenarios below independently.
1. Luxury Limos is in the business of renting limousines in New York City. It has a fleet of 200 limos. It owns the limousines that they rent, and keeps them on average for five years. In Year 3, Luxury Limos showed a loss on the sale of limos of $5,000. In Years 1 and 2 it recorded a loss on sale of $2,000 and $1,000, respectively. Should the gains and losses on the sale of limos be ignored when determining earnings persistence or not?
2. Turnaround Corporation has just hired new top management. In the new management's first year they take a huge restructuring charge (looks as though they are taking a "big bath"). Included in the restructuring charge are:
● Recognition of a contingent liability for probable environmental clean-up
● Write-down of assets (which amounted to a 50% write-down of all assets)
● A charge for a future upgrade of its computer system
For each of the items included in the restructuring charge, and considering management's possible motivation for taking a "big bath", identify how these items might affect future recorded income.

Question

Quizplus · Accepted Answer

The Answer of Problem Seven: Earnings Persistence/Future Earnings
Consider each of the scenarios below independently.
1. Luxury Limos is in the business of renting limousines in New York City. It has a fleet of 200 limos. It owns the limousines that they rent, and keeps them on average for five years. In Year 3, Luxury Limos showed a loss on the sale of limos of $5,000. In Years 1 and 2 it recorded a loss on sale of $2,000 and $1,000, respectively. Should the gains and losses on the sale of limos be ignored when determining earnings persistence or not?
2. Turnaround Corporation has just hired new top management. In the new management's first year they take a huge restructuring charge (looks as though they are taking a "big bath"). Included in the restructuring charge are:
● Recognition of a contingent liability for probable environmental clean-up
● Write-down of assets (which amounted to a 50% write-down of all assets)
● A charge for a future upgrade of its computer system
For each of the items included in the restructuring charge, and considering management's possible motivation for taking a "big bath", identify how these items might affect future recorded income.