Reading 26: Evaluating Financial Reporting Quality LOSd～

recent, company, sporting, companies, successful

Q5. Nolan Corporation (Nolan) is a successful and publicly-traded U.S. company that has operated for many years. It manufactures

various sporting goods and in recent years, established three subsidiary companies, Soccer Inc. (Soccer), Hockey Inc.

(Hockey), and Lacrosse Inc. (Lacrosse). Soccer and Hockey are located in the U.S. and Lacrosse is located in Canada.

Given that its stock is widely followed by analysts, Nolan regularly communicates its earnings expectations to the market.

Nolan’s most recent financial statements are provided in Exhibit 1.

Exhibit 1: Consolidated financial statements for Nolan Corporation

Balance Sheet As of December 31 (in thousands)
	2008	2007
Assets	< > td>	< > td>
Cash	$1,230	$1,805
Accounts receivable	4,900	4,610
Inventory	7,240	4,830
Fixed assets, net	18,300	16,500
Total assets	$31,670	$27,745
< > td>	< > td>	< > td>
Liabilities and Equity	< > td>	< > td>
Accounts payable	$1,860	$1,200
Current portion of long-term debt	3,306	3,095
Long-term debt	22,000	20,000
Total liabilities	$27,166	$24,295
Common stock	2,000	2,000
Retained earnings	2,504	1,450
Total Liabilities and Equity	$31,670	$27,745

Income Statement Year Ended December 31, 2008 (in thousands)
Sales	$21,500
Cost of goods sold	(13,620)
Depreciation expense	(2,100)
SG&A expense	(1,750)
Interest expense	(1,420)
Taxes	(910)
Net income	$1,700

Cash flow Statement Year Ended December 31, 2008 (in thousands)
Cash from operations	$1,760
Cash from investing	(3,900)
Cash from financing	1,565
Change in cash	$(575)

Nolan has calculated accrual ratios for its subsidiaries, Soccer and Hockey, in Exhibit 2.

Exhibit 2: Accrual ratios for Soccer and Hockey

Accrual Ratio	2008	2007
Soccer Inc.	13.5%	11.4%
Hockey Inc.	10.7%	11.2%

To protect itself from a multitude of business and financial risks, Nolan uses derivatives to manage its risks. It has engaged in several different hedges during the year, including a net investment hedge of a foreign subsidiary, a cash flow hedge, and a fair value hedge.

Which of the following statements best describes the term forecast error?

A) The difference in a firm’s reported earnings and the consensus buy-side earnings forecast.

B) The difference in a firm’s reported earnings and the consensus sell-side earnings forecast.

C) The difference in a firm’s reported earnings and the firm’s internal earnings forecast communicated to the market.

Q6. Using Nolan’s consolidated balance sheet, which of the following amounts is closest to the accruals ratio for 2008.

A) 15.5%.

B) 16.6%.

C) 14.4%.

Q7. Using Nolan’s consolidated income statement and cash flow statement, which of the following amounts is closest to the

accruals ratio for 2008. (Note: for the purposes of this question, assume that the average NOA is $24,000.)

A) 16.0%.

B) -1.8%.