The potentially serious consequences of bad earnings management are illustrated by the case of Atlas Cold Storage Income Trust, which operates a system of refrigerated warehouses across Canada and the United States. During June 2004, the Ontario Securities Commission filed quasi-criminal charges under the Ontario Securities Act against four senior officials of the company, including its CEO. The company itself was not charged because it cooperated with the investigation and took steps to remedy the problems.

The OSC charged that during 2001-2003, Atlas had engaged in several types of financial statement manipulations. One tactic was to Capitalize certain costs that, according to GAAP, should have been charged to expense. Another involved deferring recognition of a large customer claim for damaged goods from 2001, where it belonged, to 2002. A third tactic was to disguise breaches of debt covenants by a subsidiary company by advancing money to the subsidiary at financial statement dates. These advances were repaid shortly thereafter. According to revised financial statements filed by the company, net income was originally reported too high by $5.2 million for 2001 and $32.4 million for 2002. The company also faced a class-action lawsuit by investors.
Required

a. Evaluate the short-run (i.e., one year) and long-run effectiveness of capitalizing expenses as an earnings management device.

b. The motivation for some of the claimed manipulations was apparently to meet earnings targets. Why is it important to managers to meet earnings targets? Use concepts of market efficiency and investor rationality in your answer.

c. With respect to earnings targets, Coca-Cola Co. announced in December 2002 that it was discontinuing the provision of quarterly and annual earnings forecasts to analysts.
Some other large public companies, including BCE Inc., have taken similar action. Why would they do this?