Reading 28: Financial Reporting Quality: Red Flags and Accou company, likely, itself, style

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1.Stinson Motors is attempting to make itself look more profitable. To accomplish this, the company is most likely to:

A)   overstate sales.

B)   overstate equity.

C)   understate assets.

D)   understate tax benefits.

2.Which of the follow characteristics is the least compelling evidence that a company has a conservative financial-reporting strategy?

A)   Earnings growth has been steady and dependable over the last few years.

B)   The LIFO method is used.

C)   Fixed assets are carried at book value.

D)   Financial statements are detailed and easy to understand.

3.Joan Zeller, CFA, suspects Cornwall Carpets is overstating its profits. Which of the following is least likely to motivate Cornwall to overreport?

A)   Cornwall’s debt covenants are strict.

B)   Wall Street’s growth expectations are high.

C)   Cornwall is attempting to get lawmakers to institute a tariff.

D)   Cornwall depends heavily on stock options to compensate its employees.

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答案和详解如下：

1.Stinson Motors is attempting to make itself look more profitable. To accomplish this, the company is most likely to:

A)   overstate sales.

B)   overstate equity.

C)   understate assets.

D)   understate tax benefits.

The correct answer was C)

Understating assets could make the return on asset ratio, a measure of profitability, look more attractive. Overstating sales or equity would make profit margins and ROE look lower, or less attractive. Understating tax benefits is the equivalent of understating earnings, which would have a negative effect on profitability.

2.Which of the follow characteristics is the least compelling evidence that a company has a conservative financial-reporting strategy?

A)   Earnings growth has been steady and dependable over the last few years.

B)   The LIFO method is used.

C)   Fixed assets are carried at book value.

D)   Financial statements are detailed and easy to understand.

The correct answer was A)

The LIFO method is considered a more conservative strategy for inventory accounting than FIFO. Most fixed assets are carried at book value – that fact alone says nothing about a company’s financial reporting. Overall, detailed financial statements presented in an easy-to-understand fashion are the hallmarks of a company with excellent disclosure, another sign of conservative accounting. But steady earnings growth can be a sign of manipulation of the numbers. It is not a sure sign, but of the choices, the earnings growth is the only one that presents a yellow flag with regards to earnings quality.

3.Joan Zeller, CFA, suspects Cornwall Carpets is overstating its profits. Which of the following is least likely to motivate Cornwall to overreport?

A)   Cornwall’s debt covenants are strict.

B)   Wall Street’s growth expectations are high.

C)   Cornwall is attempting to get lawmakers to institute a tariff.

D)   Cornwall depends heavily on stock options to compensate its employees.

The correct answer was C)

The satisfaction of debt covenants and profit estimates are strong incentives to overstate earnings. Since stock prices tend to follow earnings over time, the use of stock for compensation could drive executives to inflate profit numbers. However, a company attempting to get trade relief is more likely to underreport earnings.

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