Earnings Management and Inventory

Question 1

__________ _____________ occurs when management uses “discretion” to mask the underlying economic performance of a company.

Answer 1

Earnings management

Question 2

What are the two main motives for utilizing earnings management?

Answer 2

1. the desire to mislead financial statement users to gain economic advantage
2. the desire to influence legal contracts to specify contractual obligations and outcomes

Question 3

_______ ____ ________ describes the extent to which reported income reflects the underlying economic performance of a company.

Answer 3

quality of earnings

Question 4

What are the four main tactics of earnings management?

Answer 4

transaction timing, overly optimistic / pessimistic estimates, channel stuffing and strategic timing of gains / losses

Question 5

The earnings mgmt tactic that includes timing the transaction accordingly to when the money makes sense to be depicted.

Answer 5

transaction timing

Question 6

The earnings mgmt tactic that includes taking advantage of the extensive use of estimates in accrual accounting, such as depreciation.

Answer 6

overall optimistic. / pessimistic estimates

Question 7

The earnings mgmt tactic that includes the company using market power over customers to induce them to purchase more goods than necessary to meet immediate needs.

Answer 7

channel stuffing

Question 8

The earnings mgmt tactic that includes gains / losses timed to maintain steady improvement in income each year, part of strategic timing of gains/losses.

Answer 8

income smoothing

Question 9

The earnings mgmt tactic that includes the recognition of nonrecurring loss in a period of already depressed income.

Answer 9

big bath

Question 10

________ includes items a company intends to sell to customers in the ordinary course of business.

Answer 10

inventory

Question 11

Inventory starts out as a ______ ________ on the ________ __________.

Answer 11

current asset on the balance sheet

Question 12

Inventory, when sold, transitions to a _____ ____ ______ ______ on the ________ __________.

Answer 12

cost of goods sold (COGS) on the income statement

Question 13

A ___________ company purchases inventory ready to sell to customers, do not produce or manufacture it.

Answer 13

merchandising

Question 14

A ___________ company produces goods that are then sold, buying inputs that go through the manufacturing process.

Answer 14

manufacturing

Question 15

What are the three manufacturing inventory classifications?

Answer 15

raw materials inventory, work-in-progress inventory, and finished goods inventory

Question 16

This classification of manufacturing inventory includes parts and materials purchased from suppliers for use in the production process.

Answer 16

raw materials

Question 17

This classification of manufacturing inventory includes inventory of partially completed goods; includes materials, labor and overhead cost.

Answer 17

work-in-progress

Question 18

This classification of manufacturing inventory includes completed products ready for delivery.

Answer 18

finished goods

Question 19

What are the three cost flow assumptions?

Answer 19

LIFO, FIFO and Average Cost

Question 20

This cost flow assumption assumes that a company uses (sells) goods in the order in which they’re purchased.

Answer 20

the FIFO method

Question 21

This cost flow assumption assumes that a company uses (sells) the most recently purchased goods first.

Answer 21

the LIFO method

Question 22

This cost flow assumption assumes that a company prices COGS and inventory based on the average cost of the items available during the period.

Answer 22

the average cost (AC) method

Question 23

At the end of the period, under the _____ method, the COGS contains the earliest items purchased / manufactured and the inventory includes the most recent items purchased / manufactured.

Answer 23

FIFO

Question 24

At the end of the period, under the _____ method, the COGS contains the most recent items purchased / manufactured and the inventory includes the earliest items purchased / manufactured.

Answer 24

LIFO

Question 25

The _____ inventory cost flow assumption generally represents the actual flow of goods.

Answer 25

FIFO

Question 26

Company should recognize all inventory to which it holds _____ ________.

Answer 26

legal title

Question 27

This inventory reporting scheme includes the title of ownership shifting when the item shipped from the seller to the buyer (while in transit, the buyer owns it).

Answer 27

FOB shipping point

Question 28

The inventory reporting scheme includes the title of ownership shifting when the item is received by the buyer from the seller (while in transit, the seller owns it).

Answer 28

FOB destination

Question 29

What is the purpose of lower of cost or net realizable value?

Answer 29

used so that companies can evaluate their unsold inventory to determine if it has declined in value at all – should the company expect the same amount of money for the sale of old inventory?

Question 30

The historical cost at which the inventory is carried in the balance sheet is the _____.

Answer 30

cost

Question 31

How do you calculate the net realizable value?

Answer 31

total - what you’re not getting

Question 32

Rule of thumb for LCNRV problems?

Answer 32

look at the total cost versus the total net realizable value and use the LOWER NUMBER

Question 33

Recording an LCNRV causes the assets on the balance sheet to ______ and the expenses on the income statement to ________.

Answer 33

decrease in assets on BS, increase in expenses on IS

Question 34

Under US GAAP, reversals of LCNRV write-downs are _________.

Answer 34

prohibited

Question 35

Companies who use the ______ method may do so to experience higher pretax income, higher income taxes and less cash available.

Answer 35

FIFO

Question 36

Companies who use the ______ method may do so to experience lower pretax income, lower income taxes and more cash available.

Answer 36

LIFO

Question 37

What three main accounts do inventory errors impact?

Answer 37

COGS, net income and retained earnings

Question 38

If a firm expects to incur a net loss on the future sale of inventory, that loss must be recognized _______.

Answer 38

now! immediately!

Question 39

The difference between LIFO cost and the current value of the inventory is known as the ____ _________.

Answer 39

LIFO reserve

Question 40

What are some of the purposes of inventory disclosures?

Answer 40

• the magnitude of a company’s investment in inventory is often huge
• risks of inventory losses are high
• they can provide insight into future performance
• high inventory levels = substantial costs for a company (storage, insurance, etc.)

Question 41

What is the equation for inventory purchases?

Answer 41

beginning balance + purchases - COGS = ending balance