Lecture 4: Accounting analysis (2)

Question 1

Name 3 opportunities for accounting adjustments

Answer 1

• accounting rules do not do a good job in capturing the firm’s business
• managers use their discretion to distort their performance
• legitimate differences in opinions between management and analysist on the economic benefit of assets

Question 2

Name 4 reasons why distortions arise from ambiguities

Answer 2

• the firms owns/controls the economic resource
• future economic benefits can be measured with reasonable certainty
• fair values of assets fall below their book values
• fair value estimates are accurate

Question 3

Overstated assets: incentives to inflate reported earnings can result in overstated assets. Some of the most common funds include (name 4)?

Answer 3

• understated depreciation/amortization of non-current assets
• delayed write downs of current or non-current assets
• understatement of allowences
• accelerated recognition of revenues

Question 4

Understated assets: incentives for earnings to be underreported. Name 4?

Answer 4

• leased assets or key intangible assets off balance sheet
• overstated allowences
• discounted receivables off balance sheet
• conservatism in IFRS (RD expenses, internally created intangible assets)

Question 5

Operating leases result in? (d/e, r/a, credit, current ratio)

Answer 5

• lower debt/equity and higher r/a
• improve lessee’s ability to obtain future credit
• current ratio (curr assets/curr liabilities) becomes larger

Question 6

Understated liabilities arise from? name 2 reasons

Answer 6

• incentives to overstate earnings or the strength of financial position
• difficulties in estimating the amount of future financial commitments

Question 7

Liabilities may be understated under some of the following conditions: name 5.

Answer 7

• aggresive revenue recognition
• off-balance sheet loans related to receivables
• off-balance sheet non-current liabilities
• understated provisions
• pension and post-retirement obligation understatements

Question 8

What is the contingent liability and what are the relevant recommendations:

• probable and reasonably estimated
• probable and not estimable
• reasonbly possible
• remote

Answer 8

• provision
• footnote disclosure
• footnote disclosure
• no financial statement or disclosure