© 2000 John Petroff
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© 2000 John Petroff |
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Questions for Chapter 13 Earnings
Review questions:
Q-13.1
When does a company stock is not considered worthless even though
the company experiences continuous losses year after year?
Q-13.2 What are the two concepts
of profitability?
Q-13.3 What does earnings
power mean?
Q-13.4 Is it essential to
emphasize profits maximization over all other corporate goals?
When is it not appropriate to do so?
Q-13.5 What different types
of information do earnings give to investors, management, customers
and others?
Q-13A.1 Are the distortions in
the income statement larger or smaller than the distortions in
the balance sheet? Explain.
Q-13A.2 Why are the distortions in the income statement more important
than the distortions in the balance sheet?
Q-13A.3 What are the different (three or four) types of distortions
in the income statement?
Q-13A.4 Are distortions in the income statement usually or often
the result of an intent to defraud? Explain.
Q-13A.5 Are distortions in the income statement deliberate or
voluntary on the part of management or accountants. Explain.
Q-13A1.1
Why are accounting principles a source of potential distortions
in the income statement?
Q-13A1.2 How is revenue
recognition a source of distortion?
Q-13A1.3 What accounting
method of inventory can cause distortions?
Q-13A1.4 What method LIFO,
FIFO or average cost, will boost income in period of high inflation?
Q-13A1.5 What method LIFO,
FIFO or average cost, will boost income when inflation is moderate?
Q-13A1.6 Can cost of goof
sold be changed by switching from full-absorption cost to standard
cost? How?
Q-13A1.7 Explain how a
decision on treating some expenses as fixed or variable can affect
the income reported for the year.
Q-13A1.8 How does the choice
of depreciation method provide opportunities for modifying reported
income?
Q-13A1.10 Which depreciation
method is most commonly used by American firms on their income
statement?
Q-13A1.11 Does GAAP give
useful lives for every type of fixed asset? How does that affect
the calculation of depreciation?
Q-13A1.12 Does the age
of equipment used by different firms in the same industry affect
the depreciation taken by each firm? Explain.
Q-13A1.13 How many different
methods are there to calculate pension cost under GAAP?
Q-13A1.14 What are the
different elements that affect the calculation of pension cost
using the defined benefit method? What are they?
Q-13A1.15 Do all firms
in an industry use the same pension cost method? Explain.
Q-13A1.16 Does GAAP give
specific guidelines on the amount of discretionary expenses firms
ought to enter in their income statement? Why or why not?
Q-13A2.1
Does the accrual method of accounting increase or decrease the
potential for distortion in the income statement?
Q-13A2.2 Are firms allowed
to make corrections to prior year results? How and why is this
make possible?
Q-13A2.3 Do distortions
in the balance sheet carry over to the income statement? Is this
true of all balance sheet distortions?
Q-13A2.4 If an item of
liabilities is overstated, how does that affect the income statement?
Give examples.
Q-13A2.5 If an item of
current assets is overstated, how does that affect the income
statement? Give examples.
Q-13A2.6 If and item of
fixed assets in understated, how does that affect the income statement?
Give examples.
Q-13A3.1
Are extraordinary items allowed under GAAP rules today? Explain.
Q-13A3.2 What is the "all
inclusive" concept? Does it allow more extraordinary items
than today's rules?
Q-13A3.3What is the "current
operating performance" concept? Does it allow more extraordinary
items that today's GAAP rule?
Q-13A3.4 Are the two concepts
("all inclusive and "current operating performance")
compatible with one another or not?
Q-13A3.5 What are the two
essential criteria for an item to be classified as an extraordinary
item?
Q-13A3.6 List the five
different types of extraordinary item.
Q-13A3.7 Should management
be held responsible for extraordinary losses? Discuss.
Q-13A3.8 Do gains or losses
from discontinued operations always appear as extraordinary items?
When and under what conditions?
Q-13A4.1
What is income smoothing?
Q-13A4.2 Is income smoothing
always intended for income statement manipulation? What other
reasons exist?
Q-13A4.3 Is income smoothing
always aimed at increasing income, or not? Explain.
Q-13A4.4 When is it logical
to make a loss worse than it is, or a large profit even larger?
If so, how is it done, and why? Give examples.
Q-13A5.1
If distortions are suspected or detected in the income sheet should
an outside analyst make correction? How about an analyst inside
the firm as an employee?
Q-13A5.2 In which circumstance,
an outside analyst must make all necessary corrections to an income
statement?
Q-13B.1
Which measures of income, absolute amounts or relative statistics,
are more useful for analysis?
Q-13B.2 Is there one measure
of profitability that encompasses all important aspects of a firm's
performance? Which is the best?
Q-13B1.1
Why would one want to average income over several years?
Q-13B1.2 What method of
averaging is recommended?
Q-13B1.3 How many years
of data are necessary to arrive at a representative income level?
Q-13B1.4 Without averaging
over several years, what measure is income is used to represent
an income without extraordinary items or discontinued operations?
Q-13B2.1
Which measures of income is most relevant for a shareholder?
Q-13B2.2 Give the simplest
formula for earning per share.
Q-13B2.3 How is earnings
per share adjusted is the number of share outstanding has changed
over the year?
Q-13B2.4 What weights are
used in the calculation of a weighted average of shares outstanding?
Q-13B2.5 List the different
causes of a change in shares outstanding.
Q-13B2.6 Are stock splits
and stock dividends assumed to affect outstanding shares on the
date announced, on the date actually distributed, as of the beginning
of the year or as of the end of the year?
Q-13B2.7 Why should preferred
stock dividends be excluded from earning per share?
Q-13B2.8 When a company
has an extraordinary item, a change in accounting method or a
discontinued operation, does the earning per share include them
or not?
Q-13B2.9 When is corporation
said to have a complex capital structure?
Q-13B2.10 Give formula
for basic earning per share.
Q-13B2.11 In what circumstances,
diluted earning per share equals basic earnings per share?
Q-13B2.12 What adjustments
are made to basic earnings per share in arriving at diluted earnings
per share?
Q-13B2.13 List the most
common types of potential common shares.
Q-13B2.14 If a potential
common share includes a payment (such as a warrant requiring a
subscription to purchase a share), how is the assume payment treated?
Q-13B2.15 When are outstanding
convertible securities assume to be converted?
Q-13B2.16 Is the method
of calculating earnings per share different under GAAP and under
international accounting standards?
Q-13B3.1
Give simplest formula for return on total assets.
Q-13B3.2 What adjustment
is recommended to return on total assets (especially if the productive
facilities have changed over the year)?
Q-13B3.3 What are some
of the reasons why averaging of total assets is not always performed
when calculating return on assets?
Q-13B3.4 Give formula for
DuPont break down.
Q-13B3.5 What is the purpose
of DuPont break down?
Q-13B3.6 What adjustment
is performed to total assets when there are intangible or unproductive
assets on the balance sheet?
Q-13B3.7 What adjustment
is performed to avoid distortions due to difference in effective
tax rate among companies?
Q-13B3.8 What problem is
present in before tax return on total assets?
Q-13B3.9 What adjustment
is performed to reflect income earning by all funds provided?
Q-13B3.10 Give formula
for return on total funds provided after tax.
Q-13B3.11 Give formula
for return on total funds provided before tax.
Q-13B3.12 Give formulas
for return of permanent funds after and before tax.
Q-13B4.1
What capital is included, and what capital is excluded from equity
in return on equity?
Q-13B4.2 What adjustment
is performed on equity in return on equity?
Q-13B4.3 Give formula of
return on net worth before and after tax.
Q-13B4.4 Give formula for
return on market capitalization.
Q-13B4.5 What is the purpose
of calculating the return on market capitalization?
Q-13B4.6 How is the equity
in return on market capitalization calculated?
Q-13B4.7 What does one
obtain if numerator and denominator of return on market capitalization
are divided by the number of shares outstandinG?
Q-13B4.8 What is the inverse
of return on common stock?
Q-13B4.9 Give formula for
dividend yield.
Q-13C.1
What are the three major strategic sources of earnings power?
Q-13C.2 List some of the
objectives of incurring expenses.
Q-13C.3 Show how objectives
in the above list can be conflicting.
Q-13C.4 What is being analyze
when looking at expense items?
Q-13C1.1
Product unit costs should correspond to which strategy?
Q-13C1.2 When can unit
costs be expected to be high?
Q-13C1.3 When can unit
costs be expected to be low?
Q-13C1.4 What does an aggressive
price strategy imply for gross profit margin?
Q-13C2.1
What expenses should reflect an aggressive marketing strategy?
Q-13C2.2 Should an aggressive
marketing strategy be also observed in balance sheet items? Which?
Q-13C2.3 How is a defensive
marketing strategy reflected in expenses?
Q-13C3.1
In which industries, is salary expense the largest expense?
Q-13C3.2 How do salaries
impact earnings power?
Q-13C3.3 Where is a company's
personnel strategy shown other than in salaries expense?
Q-13C4.1
How can depreciation reflect the age of fixed assets and a company's
capital budgeting strategy?
Q-13C4.2 What indications
of quality and quantity of fixed assets can be used other than
depreciation?
Q-13C5.1
Which item of expense is likely to be the most stable?
Q-13C6.1
In which industries R&D expense is of crucial importance?
Q-13C6.2 Is R&D expense
extensively discussed in annual reports of firms such as pharmaceutical
companies? Why and how?
Q-13C6.3 How can the R&D
expense be confirmed by external written information?
Q-13C7.1
How should interest expense reflect an aggressive marketing strategy?
Q-13C8.1
Which item of expense is the least comparable between firms of
different countries?
Q-13C8.2 What type of tax
is most significant for American companies?
Q-13C8.3 What type of tax
is most significant for European companies?
Q-13C8.4 Why is the corporate
income tax on the income statement not the one actually paid to
tax authorities?
Q-13C8.5 Give examples
of deferred income tax liabilities.
Q-13C8.6 Give examples
of deferred income tax assets.
Q-13C8.7 What three type
of information pertaining to taxes must appear in notes to financial
statements of American companies?
Q-13C8.8 It the tax related information in notes to financial
statements sufficient to reveal if the company has an appropriate
tax saving strategy? Why?
Q-13C9.1
Discuss to what extent other income and expenses such as extraordinary
items, discontinued operations and changes in accounting method
should be part of earnings power assess of the company.
Q-13C10.1
List examples of discretionary expenses.
Q-13C10.2 Why are discretionary
expenses revealing of company strategies?
Q-13C10.3 Which discretionary
expenses are critical and which are optional?
Q-13C11.1
How can a time-series analysis of expense be used instead of ratios?
Q-13C11.2 For which type
of firms the time-series approach is appropriate?
Q-13C11.3 For expanding
industry firms which statistical method of analysis of expenses
in more productive than time-series analysis?
Q-13C12.1
What is the major source of information about company strategies?
Q-13C12.2 Which two parts
of the annual report are specifically aimed at providing verbal
explanations of company operations reflected in the financial
statements?
Q-13C12.3 What additional
information is present in the 10-K SEC filing?
Q-13C12.4 Are corporate
pro forma statements encouraged by the SEC?
Q-13C12.5 Are most American
corporations presenting pro forma statements in their annual reports?
Why or why not?
Q-13C12.7 How helpful
are quarterly reports to an analyst?
Q-13D.1
What is the average aggregate net profit margins of American firms
in 1999?
Q-13D1.1
Do American utilities have a lower net profit margin than other
nonfinancial companies?
Q-13D1.2 How do regulating
commission assure that regulated companies will continue to attract
investors needed for keeping expansion in line with growing demand
for services?
Q-13D1.3 How has return
on assets of gas and electric American utilities changed between
1960's and 1990's as a result of deregulation of these industries?
Q-13D2.1
Is profitability of new and old companies comparable to most average
companies? Why not?
Q-13D2.2 Have American
firms in computer related industries experience large losses during
their expansion phase in 1999? Give reasons why.
Q-13D2.3 Have losses of
American firms in expanding computer related industries been most
common among small or large firms in 1999?
Q-13D2.4 Have ratios of
American firms in contracting shoe manufacturing industry been
steady or eroding over the past 20 years?
Q-13D2.5 Has profitability
of American shoe manufacturers reflected the decline of the industry?
Comment.
Q-13D3.1
In which of the following sectors: construction, manufacturing,
wholesale, retail, transportation, information, services and utilities,
do operating expenses represent more than 80% of sales?
Q-13D3.2 In which of the
following sectors: construction, manufacturing, wholesale, retail,
transportation, information, services and utilities, do operating
expenses represent less than 40% of sales?
Q-13D4.1
Based on net profit margin, in which two sectors do economies
of scale have a strong effect on profitability in 1999?
Q-13D4.2 Based on net profit
margin, in which three sectors do economies of scale have no effect
on profitability in 1999?
Q-13D4.3 Based on net profit
margin, in which two sectors do economies of scale have a moderate
effect on profitability in 1999?
Q-13D4.4 Based on return
on equity, do economies of scale have an impact for most sectors
in 1999?
Q-13D5.1
Why do the smallest American firms have a higher return on equity
than mid size firms?
Q-13D6.1
When comparing firms on the basis of their size, which is decreasing
more as size increases: relative size of operating costs or gross
profit?
Q-13E.1
Outline the percent-of-sales method of forecasting earnings.
Q-13E.2 What are the shortcomings
of the percent-of-sales forecasting method?
Q-13E.3 When are the shortcomings
of the percent-of-sales forecasting method not a major problem?
Q-13E.4 How is pricing predicted
for a company?
Q-13E.5 What are determinants
of unit cost projections?
Q-13E.6 What influences
most overhead expense projection?
Q-13E.7 What strategy and
market conditions must be carefully studied to predict salary
expense?
Q-13E.8 What factors are
used to predict interest expense?
Q-13E.9 Which information
is used to predict R&D expense?
Q-13E.10 How difficult is
it to predict discretionary expenses? Should an analyst avoid
making projections?
Q-13E.11 How and why is
a forecast error calculated?
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