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Chapter 4: Q2CA_(a) (page 190)

Bobek Inc. has recently reported steadily increasing income. The company reported income of \(20,000 in 2014, \)25,000 in 2015, and \(30,000 in 2016. A number of market analysts have recommended that investors buy the stock because they expect the steady growth in income to continue. Bobek is approaching the end of its fiscal year in 2017, and it again appears to be a good year. However, it has not yet recorded warranty expense.

Based on prior experience, this year’s warranty expense should be around \)5,000, but some managers have approached the controller to suggest a larger, more conservative warranty expense should be recorded this year. Income before warranty expense is \(43,000. Specifically, by recording a \)7,000 warranty accrual this year, Bobek could report an increase in income for this year and still be in a position to cover its warranty costs in future years.

Instructions

(a) What is earnings management?

Short Answer

Expert verified

Earnings management is the planning of business administration to make the fluctuations in the earnings. This planning presents the increased income for the current years.

Step by step solution

01

Meaning of Financial reporting

Financial reporting is one of the crucial processes of business activities. Under this process, a business entity discloses its financial data in the form of financial statements tointernal and external users.

02

Earnings management

Earnings management refers to the technique used by the company’s management to present its financial statements in a positive manner. The principal purpose of earnings management is to attractpotential investorsand reflect a favorable view of the company’s financial position.

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Most popular questions from this chapter

Indicate where the following items would ordinarily appear on the financial statements of Boleyn, Inc. for the year 2017.

(a) The service life of certain equipment was changed from 8 to 5 years. If a 5-year life had been used previously, additional depreciation of \(425,000 would have been charged.

(b) In 2017, a flood destroyed a warehouse that had a book value of \)1,600,000. Floods are rare in this locality.

(c) In 2017, the company wrote off $1,000,000 of inventory that was considered obsolete.

(d) In 2014, a supply warehouse with an expected useful life of 7 years was erroneously expensed.

(e) Boleyn, Inc. changed from weighted-average to FIFO inventory pricing.

Vandross Company has recorded bad debt expense in the past at a rate of 1½% of accounts receivable, based on an aging analysis. In 2017, Vandross decided to increase its estimate to 2%. If the new rate had been used in prior years, cumulative bad debt expense would have been \(380,000 instead of \)285,000. In 2017, bad debt expense will be \(120,000 instead of \)90,000. If Vandross’s tax rate is 30%, what amount should it report as the cumulative effect of changing the estimated bad debt rate?

Question: What is the major distinction (a) between revenues and gains and (b) between expenses and losses?

Question: (Earnings per Share) The stockholders’ equity section of Hendly Corporation appears below as of December 31, 2017.

8% preferred stock, \(50 par value, authorized

100,000 shares, outstanding 90,000 shares \)4,500,000

Common stock, \(1.00 par, authorized and issued 10 million shares 10,000,000

Additional paid-in capital 20,500,000

Retained earnings \)134,000,000

Net income 33,000,000167,000,000

\(202,000,000

Net income for 2017 reflects a total effective tax rate of 34%. Included in the net income figure is a loss of \)18,000,000 (before tax) as a result of a non-recurring major casualty. Preferred stock dividends of \(360,000 were declared and paid in 2017. Dividends of \)1,000,000 were declared and paid to common stockholders in 2017.

Instructions

Compute earnings per share data as it should appear on the income statement of Hendly Corporation.

On January 30, 2016, a suit was filed against Frazier Corporation under the Environmental Protection Act. On August 6, 2017, Frazier Corporation agreed to settle the action and pay $920,000 in damages to certain current and former employees. How should this settlement be reported in the 2017 financial statements? Discuss.
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