FSA

Question 1

pro forma income

Answer 1

• adjusted income that is non-GAAP and excl non-recurring items
• must show reconciliation from income statements to adjusted income

Question 2

abnormal accruals compared between firms

Answer 2

accruals would be scaled— by average assets or by average net operating income.

Question 3

M-score

Answer 3

Score indicating probability of earnings manipulation

Question 4

DSR (days sales receivable index)

Answer 4

(Receivablest/Salest)/(Receivablest−1/Salest−1).

could indicate inappropriate revenue recognition.

Question 5

GMI (gross margin index)

Answer 5

Gross margin t−1/Gross margin t

Deterioration in margins could predispose companies to manipulate earnings.

Question 6

AQI (asset quality index)

Answer 6

[1 − (PPEt + CAt)/TAt]/[1 − (PPEt−1 + CAt−1)/TAt−1]

Change in the percentage of assets other than in PPE and CA could indicate excessive expenditure capitalization.

Question 7

SGI (sales growth index)

Answer 7

Salest/Salest−1

Managing the perception of continuing growth and capital needs from actual growth could predispose companies to manipulate sales and earnings.

Question 8

DEPI (depreciation index)

Answer 8

Depreciation ratet−1/Depreciation ratet, where Depreciation rate = Depreciation/(Depreciation + PPE).

Declining depreciation rates could indicate understated depreciation as a means of manipulating earnings.

Question 9

SGAI (sales, general, and administrative expenses index)

Answer 9

(SGAt /Salest)/(SGAt−1/Salest−1)

An increase in fixed SGA expenses suggests decreasing administrative and marketing efficiency, which could predispose companies to manipulate earnings.

Question 10

Accruals

Answer 10

(Income before extraordinary items − Cash from operations)/Total assets.

Higher accruals can indicate earnings manipulation.

Question 11

LEVI (leverage index)

Answer 11

Leveraget/Leveraget−1, where Leverage is calculated as the ratio of debt to assets.

Increasing leverage could predispose companies to manipulate earnings.

Question 12

These practices are often referred to as “tunneling”

Answer 12

Dealings between a public company and the manager-owned entity might take place at prices that are unfavorable for the public company in order to transfer wealth from the public company to the manager-owned entity. Such inappropriate transfers of wealth can also occur through excessive compensation, direct loans, or guarantees.

Question 13

These practices are often referred to as “propping”

Answer 13

the manager-owned entity could transfer resources to the public company to ensure its economic viability and thus preserve the option to misappropriate or to participate in profits in the future.

Question 14

Altman developed a model to discriminate between two groups: bankrupt and non-bankrupt companies. Altman’s Z-score is calculated as follows:

Answer 14

Z-score = 1.2 (Net working capital/Total assets) + 1.4 (Retained earnings/Total assets) + 3.3 (EBIT/Total assets) + 0.6 (Market value of equity/Book value of liabilities) + 1.0 (Sales/Total assets)