1. Century Appliance Company has achieved fast growth in the Atlanta area by selling service contracts on large appliances such as washers, dryers and refrigerators. For a fee, Century Appliance agrees to provide all parts and labor on appliances after the regular warranty runs out. For example, by paying a fee of $200, a person who buys a dishwasher can add two years to the regular one year warranty on the appliance. In 2008, the company sold service contracts in the amount of $1.8 million, all of which applied to future years. Management wanted all the sales recorded as revenues in 2008, contending that the amount of the contracts could be determined and the cash had been received. Is Century Appliance Company’s action earnings management or fraud? Why?
Fraud – violation of revenue recognition; non-GAAP – three year warrantee, 1/3 should be recognized each year.
2. Desiree Inc., which has a December 31 year end, designs and sells fashions for young professional women. Susan Andersen, president of the company, feared that the forecasted 2008 profitability goals would not be reached. She was pleased when Desiree Inc. received a large order on December 30, 2008, from The Executive Woman, a retail chain of upscale stores for business women. Andersen immediately directed the controller to record the sale, which represented 13 percent of Desiree's annual sales. What will be the effect of Andersen’s action on Desiree's 2008 profitability? What will be the effect on 2009 profitability? Was Andersen's action simply "managing the earnings" or an act of fraud? Why?
It will raise the 2008 profitability and lower the 2009 profitability. It is fraud – the amount hasn’t yet been earned because the clothing has not yet been shipped
3. Joe Chief is the Chief Financial Officer of a new company. He decides to use the income statement approach to estimate bad debts rather than the balance sheet approach because he wants bad debts expense to be more accurately reflected on the income statement. He is not as concerned about how accurate the allowance for doubtful accounts is on the balance sheet. Is this earnings management or fraud?
Earnings management – two acceptable types of recognition under GAAP
4. The Badly Company is having a bad year. They decide to postpone some significant maintenance expenses in their warehouse until next year because they don’t want to record any more expenses this year. Is this earnings management or fraud?
Earnings management – operations decision in delayed maintenance
5. A company selects the LIFO method of inventory valuation to reduce income taxes. Is this earnings management or fraud?
Earnings management
Quick Reply
