Ch. 6: Reporting & Analysing Revs, Receivables & Operating Income

Question 1

Ageing analysis for uncollectible accounts

Answer 1

Focuses on receivables owed by customers that might be uncollectible

Question 2

Percentage of sales for uncollectible accounts

Answer 2

Focuses on potentially uncollectible accounts among current period sales

Question 3

Pledging receivables

Answer 3

Using receivables as collateral for a loan.

Disclosed in footnotes.

A short-term loan is also presented in the liabilities section of the balance sheet

Question 4

Factoring receivables

Answer 4

Selling receivables to a bank or other financial institution.

Receivables are removed from the balance sheet if sold

Question 5

Earnings management

Answer 5

Occurs when management uses discretion to mask the underlying economic performance of a company

Question 6

Motives for earnings management

Answer 6

1. The desire to mislead some financial statement users about the financial performance of the company to gain economic advantage.
2. The desire to influence legal contracts that use reported accounting numbers to specify contractual obligations and outcomes.

Question 7

Channel stuffing

Answer 7

Arises when a company uses its market power over customers to induce them to purchase more goods than necessary to meet immediate needs.

Usually occurs immediately before the end of a seller’s accounting period.

Causes seller’s revenue to increase

Question 8

Income smoothing

Answer 8

Occurs when management times gains or losses in order to maintain a steady improvement in income each year

Question 9

Big bath

Answer 9

Occurs when management reports the recognition of a nonrecurring loss in a period of
already depressed income

Question 10

Quality of earnings

Answer 10

A term that analysts use to describe the extent to which reported income reflects the underlying economic performance of a company.

Often compromised by earnings management.

Question 11

Time-trend analysis

Answer 11

How the firm’s performance is

changing through time

Question 12

Peer group analysis

Answer 12

Compare to similar companies or within industries

Question 13

Profit margin

Answer 13

Captures profitability.

Measures net profit that is generated from each dollar of sales revenue.

Profit margin = Net income (NI) / Sales

Question 14

Return on assets (ROA)

Answer 14

Relates net income to the total assets of the company.

It is a measure of the effectiveness of resource utilisation.

This measure does not take into account how those assets were financed.

This ratio improves with share buybacks.

ROA = NI / Total assets (Avg for the period)

Question 15

Return on equity (ROE)

Answer 15

Relates net income to the amount invested by stockholders.

It is a measure of the return that shareholders are obtaining on their contribution (and retained earnings).

This ratio improves with share buybacks.

ROE = NI / Equity (Avg for the period)

Question 16

Accounts receivable turnover (ART)

Answer 16

Reflects the investment in receivables required to generate one dollar of sales.

ART = Sales rev. / Avg. Accounts receivable