Reference no: EM132248962
EXERCISE
The president of Vancouver Viacom made the following comments to shareholders:
Regarding management attitudes, Vancouver Viacom has resisted joining an increasing number of companies who along with earnings announcements make extraordinary or nonrecurring loss announcements. Many of these cases read like regular operating problems. When we close plants, we charge earnings for the costs involved or reserved as we approach the event. These costs, in my judgment, are usually a normal operating expense and something that good management should expect or anticipate. That, of course, raises the question of what earnings figure should be used in assessing a price-earnings ratio and the quality of earnings.
Required:
a. Discuss your reactions to these comments.
b. What factors determine whether a gain or loss is extraordinary?
c. Explain whether you would classify the following items as extraordinary and why.
(1) Loss suffered by foreign subsidiaries due to a change in the foreign exchange rate.
(2) Write-down of inventory from cost to market.
(3) Loss attributable to an improved product developed by a competitor.
(4) Decrease in net income from higher tax rates.
(5) Increase in income from liquidation of low-cost LIFO inventories due to a strike.
(6) Expenses incurred in relocating plant facilities.
(7) Expenses incurred in liquidating unprofitable product lines.
(8) Research and development costs written off from a product failure (non-marketed).
(9) Software costs written off because demand for a product was weaker than expected.
(10) Financial distress of a major customer yielding a bad debts provision.
(11) Loss on sale of rental cars by a car rental company.
(12) Gains on sales of fixed assets.
(13) Rents received from employees who occupy company-owned houses.
(14) Uninsured casualty losses.
(15) Expropriation by a foreign government of an entire division of the company.
(16) Seizure or destruction of property from an act of war.
11-1. Why is analysis of research and development expenses important in assessing and forecasting earnings? What are some concerns in analyzing research and development expenses?
11-2. What is the relation between the reported values of assets and reported earnings? What is the relation between the reported values of liabilities, including provisions, and reported earnings?
11-3. What is the purpose in recasting the income statement for analysis?
11-4. Where do we find the data necessary for analysis of operating results and for their recasting and adjustment?
11-5. Describe the recasting process. What is the aim of the recasting process in analysis?
11-6. Describe the adjustment of the income statement for financial statement analysis.
11-7. Explain earnings management. How is earnings management distinguished from fraudulent reporting? 11-8. Identify and explain at least three types of earnings management.
11-9. What factors and incentives motivate companies (management) to engage in earnings management? What are the implications of these incentives for financial statement analysis?
11-10. Why is management interested in the reporting of extraordinary gains and losses? 11-11. What are the analysis objectives in evaluating extraordinary items?
11-12. What three categories can unusual or extraordinary items be usefully subdivided into for purposes of analysis? Provide examples for each category. How should an analysis treat items in each of these cate¬gories? Is a certain treatment implied under all circumstances? Explain.
11-13. Describe the effects of extraordinary items on:
a. Company resources.
b. Management evaluation.