Reading 40: Financial Reporting Quality: Red Flags and Accou 2011, activities, records, center, result

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Session 10: Financial Reporting and Analysis: Applications and International Standards Convergence
Reading 40: Financial Reporting Quality: Red Flags and Accounting Warning Signs

LOS b: Describe activities that will result in a low quality of earnings.

 

 

Samson Therapeutics records all leases as operating leases. The company most likely wanted to reduce:

A) expenses.

B) inventory.

C) leverage.

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Finance (capital) leases are recorded on the balance sheet, and by recording all leases as operating leases, the company can reduce its leverage. Lease accounting has no effect on inventory. "Expenses" is not the best answer as operating leases will result in higher expenses in the later years relative to the finance (capital) lease.

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Glenmark Blades and Propellers has set up special purpose entities to handle its manufacturing. The company does not consolidate those entities. Glenmark is most likely obeying:

A) neither the spirit of the law nor the letter of the law.

B) the spirit of the law but not the letter of the law.

C) the letter of the law but not the spirit of the law.

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Rules regarding special purpose entities (SPE) are quite broad, leaving companies with substantial leeway in interpretation. Separating capital-intensive manufacturing operations from the parent company’s books could give Glenmark a more appealing debt or asset picture. While companies can often opt not to consolidate SPEs, the goal of such entities is not to allow a company to manipulate its financial ratios.

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Joe Carter, CFA, believes Triangle Equipment, a maker of large, specialized industrial equipment, has overstated the salvage value of its equipment. This would:

A) overstate earnings.

B) overstate liabilities.

C) understate earnings.

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Overstating the salvage value reduces depreciation expense, which in turn increases earnings.