l11 : positive accounting theory

Question 1

state some examples of exceptional items in financial statements.

Answer 1

• restructuring costs
• impairments
• amortisation of intangibles
• disposal of subsidiaries
• loss on disposal

Question 2

what is the debt covenant hypothesis?

Answer 2

closer the firm is to violation of debt covenants (conditions), more likely mgt is to EM to shift reported future earnings to current period

Question 3

what is leverage covenant?

Answer 3

measure of profit before separately disclosed items, interest, tax, depreciation, amortisation, aircraft operating lease rentals & exceptional items compared to net debt

Question 4

state the equation for leverage covenant.

Answer 4

underlying EBIT before depreciation, amortisation, aircraft op. lease charges & exceptional items / net debt

Question 5

what is fixed charge covenant?

Answer 5

measure of profit before separately disclosed items, interest, tax, depreciation, amortisation, operating lease charges & other exceptional items compared to net interest and operating lease charges

Question 6

state the equation for fixed charge covenant.

Answer 6

underlying EBIT before depreciation, amortisation, op. lease charges & other exceptional items / net interest & operating lease charges

Question 7

what happens to debt covenant values after exceptional items are included in EBIT calculations?

Answer 7

values fall. due to the value of EBIT falling, since exceptional items are included in expenses in calculation of profit.

Question 8

why did thomas cook fail according to BEIS committee?

Answer 8

were reporting regular costs as “exceptional” whilst racking up debt and bosses receiving large bonuses and remuneration partly based on profits before tax

Question 9

how was thomas cook CEO able to receive large bonus packages related to profit?

Answer 9

used underlying EBIT instead of operating profit, meaning that appeared that CEO had met minimum performance even when he hadnt.

Question 10

how does the thomas cook collapse relate to political cost hypothesis?

Answer 10

important company for peoples welfare and so may have assumed that mgt took riskier decisions hoping for gov intervention if anything went wrong due to scale of disruption that wouldve been caused