Earnings Management and Inventory Flashcards
__________ _____________ occurs when management uses “discretion” to mask the underlying economic performance of a company.
Earnings management
What are the two main motives for utilizing earnings management?
- the desire to mislead financial statement users to gain economic advantage
- the desire to influence legal contracts to specify contractual obligations and outcomes
_______ ____ ________ describes the extent to which reported income reflects the underlying economic performance of a company.
quality of earnings
What are the four main tactics of earnings management?
transaction timing, overly optimistic / pessimistic estimates, channel stuffing and strategic timing of gains / losses
The earnings mgmt tactic that includes timing the transaction accordingly to when the money makes sense to be depicted.
transaction timing
The earnings mgmt tactic that includes taking advantage of the extensive use of estimates in accrual accounting, such as depreciation.
overall optimistic. / pessimistic estimates
The earnings mgmt tactic that includes the company using market power over customers to induce them to purchase more goods than necessary to meet immediate needs.
channel stuffing
The earnings mgmt tactic that includes gains / losses timed to maintain steady improvement in income each year, part of strategic timing of gains/losses.
income smoothing
The earnings mgmt tactic that includes the recognition of nonrecurring loss in a period of already depressed income.
big bath
________ includes items a company intends to sell to customers in the ordinary course of business.
inventory
Inventory starts out as a ______ ________ on the ________ __________.
current asset on the balance sheet
Inventory, when sold, transitions to a _____ ____ ______ ______ on the ________ __________.
cost of goods sold (COGS) on the income statement
A ___________ company purchases inventory ready to sell to customers, do not produce or manufacture it.
merchandising
A ___________ company produces goods that are then sold, buying inputs that go through the manufacturing process.
manufacturing
What are the three manufacturing inventory classifications?
raw materials inventory, work-in-progress inventory, and finished goods inventory
This classification of manufacturing inventory includes parts and materials purchased from suppliers for use in the production process.
raw materials
This classification of manufacturing inventory includes inventory of partially completed goods; includes materials, labor and overhead cost.
work-in-progress
This classification of manufacturing inventory includes completed products ready for delivery.
finished goods
What are the three cost flow assumptions?
LIFO, FIFO and Average Cost
This cost flow assumption assumes that a company uses (sells) goods in the order in which they’re purchased.
the FIFO method
This cost flow assumption assumes that a company uses (sells) the most recently purchased goods first.
the LIFO method
This cost flow assumption assumes that a company prices COGS and inventory based on the average cost of the items available during the period.
the average cost (AC) method
At the end of the period, under the _____ method, the COGS contains the earliest items purchased / manufactured and the inventory includes the most recent items purchased / manufactured.
FIFO
At the end of the period, under the _____ method, the COGS contains the most recent items purchased / manufactured and the inventory includes the earliest items purchased / manufactured.
LIFO
The _____ inventory cost flow assumption generally represents the actual flow of goods.
FIFO
Company should recognize all inventory to which it holds _____ ________.
legal title
This inventory reporting scheme includes the title of ownership shifting when the item shipped from the seller to the buyer (while in transit, the buyer owns it).
FOB shipping point
The inventory reporting scheme includes the title of ownership shifting when the item is received by the buyer from the seller (while in transit, the seller owns it).
FOB destination
What is the purpose of lower of cost or net realizable value?
used so that companies can evaluate their unsold inventory to determine if it has declined in value at all – should the company expect the same amount of money for the sale of old inventory?
The historical cost at which the inventory is carried in the balance sheet is the _____.
cost
How do you calculate the net realizable value?
total - what you’re not getting
Rule of thumb for LCNRV problems?
look at the total cost versus the total net realizable value and use the LOWER NUMBER
Recording an LCNRV causes the assets on the balance sheet to ______ and the expenses on the income statement to ________.
decrease in assets on BS, increase in expenses on IS
Under US GAAP, reversals of LCNRV write-downs are _________.
prohibited
Companies who use the ______ method may do so to experience higher pretax income, higher income taxes and less cash available.
FIFO
Companies who use the ______ method may do so to experience lower pretax income, lower income taxes and more cash available.
LIFO
What three main accounts do inventory errors impact?
COGS, net income and retained earnings
If a firm expects to incur a net loss on the future sale of inventory, that loss must be recognized _______.
now! immediately!
The difference between LIFO cost and the current value of the inventory is known as the ____ _________.
LIFO reserve
What are some of the purposes of inventory disclosures?
- the magnitude of a company’s investment in inventory is often huge
- risks of inventory losses are high
- they can provide insight into future performance
- high inventory levels = substantial costs for a company (storage, insurance, etc.)
What is the equation for inventory purchases?
beginning balance + purchases - COGS = ending balance
