Chapter 5 A Guide to Earnings and Financial Reporting Quality

Chapter 5 A Guide to Earnings and Financial Reporting Quality

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
Chapter 5: A Guide to Earnings and Financial Reporting Quality Friday, February 24, 2012 5:22 PM 1. Sales or Revenues 1.a. Premature revenue recognition 1.a.i. GAAP: revenue should not be recognized until there is evidence that a true sale has taken place 1.a.i. Analyzing the relationship between sales, accounts receivable, and inventory can signal "red flags" if these accounts are not moving in comparable patterns 1.a. Gross versus net basis 1.a.i. Gross-refers to the total amount that the final customer pays for an item 1.a.ii. Net-refers to the gross amount less the cost of the sale, which equals the fee that is paid to the reseller of the item 1.a.iii. Some companies act as an agent between the customer and seller of a product or service…they receive the "net" amount for their role 1.a.iv. Revenues appear larger when recorded at gross amounts, but gross profit margins appear better for firms recording revenues net 1.a.v. The net amount is the most realistic amount as that is what the firm will actually receive in cash as a result of the transaction 1.a. Allowance for doubtful accounts 1.a.i. Allowance account is deducted from the balance sheet accounts receivable account 1.a.ii. There should be a consistent relationship, all other things being equal, between the rate of change in sales, accounts receivable, and the allowance for doubtful accounts 1.a.iii. If the amounts are changing at different rates or in different directions (ex: sales and AR are increasing, but the allowance account is decreasing or is increasing at a much smaller rate) the analyst should be alert to the potential for manipulation through the allowance account 1.a.iv. Underestimating bad debt expense will boost net income 1.a. Price versus volume changes 1.a.i. If a company's sales are increasing/decreasing, it is important to determine whether the change is a result of price, volume, or a combination of both factors 1.a.ii. Information should be given regarding the reasons for sales 1.a. Real versus nominal growth 1.a.i. Another issue is whether sales are growing in "real" (inflation-adjusted) as well as "nominal" (as reported) terms 1. Cost of Good Sold 1.a. Cost flow assumption for inventory 1.a.i. During periods of inflation, LIFO produces lower earnings than FIFO 1.a. Base LIFO layer liquidations 1.a.i. Occurs with the use of LIFO in a situation in which the firm sells more
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 4

Chapter 5 A Guide to Earnings and Financial Reporting Quality

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online