Chapter 11_ Solutions

Chapter 11_ Solutions - Suggested Solutions to Assigned...

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Suggested Solutions to Assigned Problems in Chapter 11: 7, 9 7. a. Reasons to resort to extreme earnings management tactics: To meet analysts’ forecasts. As stated in the question, this was the apparent reason in BMS’ case. Contractual reasons. To increase bonuses and/or to avoid debt covenant violations. Implicit contracts. To increase earnings so as to receive better terms from suppliers. In BMS’ case, this seems unlikely since wholesalers were pressed to accept excess inventory. IPO. The firm may have wanted to increase and/or smooth earnings so as to increase proceeds from a planned IPO. b. From the standpoint of a single year, stuffing the channels seems effective. This is because it is hard to detect. Such behaviour may possibly be detected through full disclosure, such as sales by product, segment, or region. Then, careful analysis may reveal unusual sales patterns. However, the company has little motivation to provide full disclosure unless required by GAAP and/or insisted upon by the auditor. Wholesalers may object if too much inventory is forced upon them. Since wholesalers are not formally BMS employees, it may be more difficult to keep them from complaining to regulators or the media. However, in BMS’ case, paying their carrying charges may have been a device to avoid such complaints. Over a series of years, stuffing the channels is likely to be less effective, for the following reasons: Page  1  of  4
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Accruals reverse. Product stuffed into the channels this year will reduce sales next year. Ever more stuffing is needed if the strategy is to be maintained. Physical limitations. There may be limits on wholesalers’ storage space.
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Chapter 11_ Solutions - Suggested Solutions to Assigned...

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