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Forensic Accounting > Midterm Earnings Mgt > Flashcards

Midterm Earnings Mgt Flashcards

0
Q

What 3 things would the financial statement analyst want to know pertaining to earnings management?

A

1 if company analyzed has manipulated/managed financial
Statement numbers
2 numbers on financial statement most likely to be managed
3 magnitude of management

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1
Q

The purpose of this paper is to review earnings management literature from the perspective of…

A

The financial statement analyst

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2
Q

This review paper reveals that an individual analyst working to understand a single company has little to guide him in assessing probability that firm has… 3 things

A

1 Managed financial statement numbers
2 which numbers have been managed
3 extent to which they have been managed

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3
Q

What is the main task of the financial statement analyst?

A

Analyst has the task of estimating a firm’s value by analyzing
financial statements of the company

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4
Q

4 typical tools analyst uses to estimate firm’s value?

A

1 horizontal analysis
2 vertical analysis
3 ratio analysis
4 industry norms

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5
Q

How does the analyst plan to calculate the present value of the future cash stream?

A

By using measure of income and a growth factor

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6
Q

2 other ways analyst plans to calculate value of company?

A

1 using comparable companies

2 price to earnings ratio

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7
Q

According to earnings management research, firm’s have been shown to manipulate earnings in some circumstances for what reasons?

A

To benefit firms or firm’s managers

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8
Q

Which 3 ratios of comparing comparable companies, would the analyst worry are effected by earnings management materially?

A

1 return on assets
2 inventory turnover
3 debt-to-equity

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9
Q

3 main questions from earnings management literature focused on in paper?

A

1 what does the literature say about which firms are likely to have
Managed financial statement numbers?
2 which numbers are likely to have been managed?
3 what amount of earnings management should be expected
For those numbers?

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10
Q

Earnings management literature does not indicate the…

A

Prevalence of management across firm’s

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11
Q

It has been shown statistically that firms in a given context are more likely to manage earnings in…

A

A predictable fashion

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12
Q

It has not been shown how many firms in the sample…

A

Manage earnings

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13
Q

Has research made it possible to predict which companies will or will not manage earnings?

A

No

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14
Q

This paper notes that earnings management research is…

A

Of little relevance to the financial statement Analyst

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15
Q

This paper is not a criticism of…

A

Earnings management literature or earnings management

researchers

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16
Q

Earnings management

A

Use of accounting discretion, intentional accounting misstatement
Or use of real transactions to alter numbers reported in financial
Statements

To influence outcomes that depend on reported accounting numbers

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17
Q

Example of using accounting discretion to influence outcome that depends on reported numbers

A

Changing depreciation methods to maintain ratios used in debt
Contracts

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18
Q

Example of using deliberate misstatement

A

Reporting sales before work is completed in order to meet

Performance goals

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19
Q

Example of altering real transactions to influence numbers reported in financial statements

A

Deferral of machine maintenance to meet analyst forecasts

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20
Q

Earnings are often managed to…

A

Meet earnings benchmarks

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21
Q

2 earnings benchmarks earnings management may try to meet?

A

1 analyst expectations

2 management earnings forecasts

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22
Q

Earnings management, how does it directly benefit the manager?

A

management compensation plans (stock price and stock option

Values)

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23
Q

Management usually manipulates earnings to…

A

Increase them slightly rather than decrease them

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24
Q

When do firms manage earnings down?

2) For what purpose?

A

Prior to management buyouts

2) To lower stock price and thus price of buyout

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25
Q

Firms manage earnings up prior to…

A

Insider sales to increase proceeds of these sales

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26
Q

Debt covenants: earnings management

A

Earnings are managed in predictable ways prior to debt covenant
Violations

27
Q

Debt covenant violations: when do firms make income increasing accounting choices?

A

To avoid default

28
Q

Debt covenant violations: when do firms make income decreasing accounting choices? 2

A

1 if debt is restructured or renegotiated

2 after technical default if they are in debt renegotiation

29
Q

Earnings are managed in predictable ways by what 3 types of firms?

A

1 healthy firms
2 firms reporting continuing losses
3 firms that are failing

30
Q

Even in healthy firms, the closer the firm is to violating debt covenant provisisions, the more likely it is to make…

A

Income-increasing accounting choices

31
Q

How are firms with continuing losses often valued?

A

Valued based on level and growth of revenue

32
Q

When are firms with continuing losses more likely to overstate revenue?

A

The longer the past and anticipated string of losses are

33
Q

In years preceding a bankruptcy firms will…

A

Manipulate earnings up

34
Q

3 instances where earnings are managed up in anticipation of major transactions or negotiations

A

1 share-for-share corporate acquisitions
2 before IPOs
3 before seasoned equity offerings

35
Q

Earnings are managed down in anticipation of what kind of negotiation?

A

Labor union negotiations

36
Q

Smooth earnings

A

Research suggests earnings are managed to smooth earnings

Stream over time

37
Q

2 reasons many firms smooth earnings

A

1 to avoid temporary decrease in earnings

2 in anticipation of future earnings

38
Q

When and why do oil firms smooth earnings?

A

To lower income during times of high oil prices

39
Q

Give an example of a significant event that causes earnings to be managed down?

A

Earnings are managed down after non routine executive changes,
Especially in firms experiencing financial distress

40
Q

Give an example of a significant event where earnings are managed before it occurs?

A

Earnings are managed down by firms in court and subject to large
Punitive damage awards

41
Q

Earnings management and government regulation 2 things

A

1 earnings are managed to meet regulatory requirements

2 earnings are managed to circulate regulatory oversight

42
Q

Not all firms that face incentives to manipulate earnings…

A

Will do so

43
Q

If there is an incentive/circumstance that warrants manipulating earnings there is…

A

An increased likelihood that manipulation of earnings will occur

44
Q

What 2 factors mitigate the incentive to manage earnings?

A

Audit committee and board of director characteristics

45
Q

Accounting choices will vary to the extent of what?

A

Manager vs. Owner control of the firm

46
Q

Earnings that have managed earnings up in recent periods have…

A

Less flexibility to manage earnings up in current period

47
Q

Beneish (1999) offers a tool for financial analysts to predict if company is managing earnings, what was the sample and function of his study?

A

Studying a sample of firms that were required to restate earnings

He creates a model to detect which firms manage earnings

48
Q

What are 5 potential red flags on financial statements that are indicative of earnings management?

A 
1 unusual increases in receivables
2 deteriorating gross margins
3 decreasing asset quality
4 sales growth
5 increasing accruals
49
Q

Decreasing asset quality, how is it measured?

A

Measured as Noncurrent asset other than property-plant-and-equipment divided by total assets

50
Q

Knowing that firms are more likely to manage earnings in a given context does not help the analyst to understand…

A

The earnings management behavior of the company under review

51
Q

The items most often used in earnings management models are…

2) how are they measured

A

Accruals

2) measured as difference between operating income and
Operating cash flows

52
Q

How are discretionary accruals measured?

A

Measured as the accruals that can’t be explained by change

In sales and level of fixed assets

53
Q

What 3 changes will the discretionary accruals measure capture?

A

1 changes in # of expenses
2 changes in some revenues
3 changes in various working capital accounts

54
Q

Discretionary accruals, other than demonstrating that income was increased or decreased, it does little to help analyst in indentifying…

A

Which financial statement numbers were changed

55
Q

Components of accruals that get manipulated vary by…

A

Context in predictable ways

56
Q

How do firms issuing equity manage accruals? 2

A

By increasing revenue and decreasing depreciation expense

57
Q

Firms managing accruals to reach an earnings benchmark use…

A

One time special items to increase income

There is little evidence documenting the kind of special item used

58
Q

What are 5 other vehicles in the form of assumptions that lead to manipulation of numbers?

A 
1 changes in pension assumptions
2 inventory method
3 depreciation method and estimates
4 LIFO liquidations
5 other one time special items
59
Q

One time special items for earnings management include: 4 things

A

1 management of write offs
2 bank loan loss provisions
3 gains from asset sales
4 pension costs

60
Q

Management of realtime transactions for earnings management 3 things

A

1 increased sales through discounting or more lenient credit terms
2 decreases in COGS through increased production
3 decreases in discretionary expenses

61
Q

3 examples of discretionary expenses

A

1 advertising
2 research and development
3 maintenance

62
Q

As a result of earnings management research the analyst will understand that some firms… 2 things

A

1 manipulate accounting numbers to manage earnings

2 vehicles chosen for manipulation vary in predictable ways

63
Q

Magnitude of earnings manipulation?

A

Median discretionary accrual for firms with debt covenant violation
And negotiations was 17.3% of total assets

Median of only 1% to meet earnings benchmark

64
Q

Papers opinion on future direction of earnings management research, 2 things

A

1 develop models that will predict which Financial statement
numbers are manipulated in given contexts and magnitude of
Manipulation
2 develop model that directly predicts amount of management
In reported earnings

65
Q

Seasoned equity offering

A

New equity issue by an already publicly traded company

Forensic Accounting (10 decks)

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