Judgement case 4-1 (earnings quality)
* LO2 LO3
The financial community in the United States has become increasingly concerned with the quality of reported company earnings.
1. Define earnings quality.
2. Explain the distinction between permanent and transitory earnings as it relates to the concept of earnings quality. 3. How do earnings management practices affect the quality of earnings? 4. Assume that a manufacturing company’s annual income statement included a large gain from sale of the investment securities. What factors would you consider in determining whether or not this gain should be included in an assessment of the company’s permanents earnings?
1. Earnings quality:
* Refers to the ability of reported earnings (income) to predict a company’s future earnings. 2. The distinction between permanent and transitory earnings are as follows: Transitory earnings:
Effects result from transactions or events that are not likely to occur again in the foreseeable future or that are likely to have a different impact on earnings in the future. Permanent earnings:
Effects result from continuing transactions/operations. It would be a mistake to assume income from continuing operations reflects permanent earnings entirely. In other words, there may be transitory earnings effects included in both operating and non-operating income. 3. It may lead us to wrong economic decisions for the true earnings quality are not truly reported hence they are manipulated through the earnings management. 4. If it would affect still the operations for the future. And it would still likely to happen or occur again in the foreseeable future, or that are likely to have the same impact on earnings in the future.
Judgement case 4-2 (Restructuring Costs)
The appearance of restructuring cost in corporate income statements increased significantly in the 1980’s and 1990’s.
1. What types of cost are included in restructuring costs? 2. When are restructuring costs recognized?
3. How would you classify restructuring cost in a multi-step income statement? 4. What factors would you consider in determining whether or not restructuring cost should not be included in an assessment of a company’s permanent earnings?
1. These are cost which are associated with shutdown or relocation of facilities or downsizing of operations. As for the PAS 37, paragraph 10, defines restructuring as a “program that is planned and controlled by management and materially changes either the scope of a business of an entity or the manner in which that business is conducted. 2. Restructuring costs are recognized in the period the exit or disposal cost obligation is incurred. 3. Classified as restructuring cost under operating expenses. 4. Recognition of the provision for restructuring is required because a constructive obligation may arise from the decision to restructure. A constructive obligation for restructuring arises when two conditions are present:
a. The entity has a detailed formal planfor the restructuring outlining at least the business or part of the business being restructured, the principal location affected, the location, function and approximate number of employees who will be compensated for terminating their employment, when the plan will be implemented, and the expenditures that will be undertaken. b. The entity has raised valid expectation in the minds of those affected that the entity will...