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oct19class - Todays Topic Earnings Quality and Income...

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Today’s Topic: Earnings Quality and Income Classification Issues (continued):
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PRO FORMA EARNINGS Cisco offered the following reconciliation ($ in millions): GAAP loss $(2,693) Add: Restructuring costs and other special charges $ 1,170 In-process research and development 109 Amortization of goodwill and other acquisition costs* 346 Payroll tax on stock options exercised 10 Inventory charges 2,249 Total adjustments $ 3,884 Tax effects (approximately 24.7% tax rate) (961) Net of tax adjustments $2,923 Pro forma net income $ 230 *New accounting standards discussed in Chapters 10 and 11 require that goodwill no longer be amortized. This standard became effective after August of 2001.
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THREATS TO EARNINGS QUALITY: MANIPULATING INCOME Two ways to manipulate income: 1. Income statement classification 2. Income shifting (Earnings Management)
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The most common income statement classification manipulation involves the inclusion of recurring operating expenses in “special charge” categories such as restructuring costs and impairment writedowns .
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Restructuring Costs Costs associated with shutdown or relocation of facilities or downsizing of operations are recognized in the period incurred. Goodwill Impairment and Long-lived Asset Impairment Involves asset impairment losses or charges.
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When are restructuring costs recognized? Prior to 2003, restructuring costs were recognized (expensed) in the period the decision to restructure was made, not in the period or periods in which the actual activities took place. Now, restructuring costs are expensed in the period(s) incurred.
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How would you classify restructuring costs in the company’s income statement? Restructuring costs would be included as an “above the line” operating expense.
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What factors would you consider in determining whether or not restructuring costs should be included in an assessment of a company’s permanent earnings? An analyst must interpret restructuring charges in light of a company’s past income statements . Information in disclosure notes describing the restructuring and management plans related to the business involved can be helpful.
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THREATS TO EARNINGS QUALITY: MANIPULATING INCOME Two ways to manipulate income: 1. Income statement classification 2. Income shifting (Earnings Management)
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INCOME SHIFTING (EARNINGS MANAGEMENT) ü Income Smoothing ü “Big Bath” ü “Cookie Jar Reserves” ü Accelerating or Decelerating Revenue Recognition (in Chapter 5)
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Income Smoothing
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Big Bath Taking restructuring costs and write-offs or impairments of assets, especially in down periods or exceptionally good periods.
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Cookie Jar Reserves Over- or under-estimating expenses in setting up allowance of contra accounts. (e.g., Bad Debts estimates) Connection with conservatism?
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Case 4-6 Carter Hawley Hale Stores (CHHS), Inc. was one of the largest department store retailers in the United States. At the end of fiscal 1989, the company operated 113 stores in the sunbelt regions of the country. The company's divisions included The Broadway, with 43 stores in Southern California
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