Exercise 11-3

Exercise 11-5

Discussion Question

This chapter focuses on equity analysis and valuation. Specifically, the module focuses on earnings persistence and earnings power. For this discussion question, the focus is the impact of integrity on earning and its implication on financial statement analysis. Please keep in mind the core values of Saint Leo University as you answer the following question.
Explain earning management. How is earnings management distinguished from fraudulent reporting?
Identify and explain at least three types of earning management.

A financial analyst s comments on income statement classifications follow: We should drop the word extraordinary and leave it to users to decide whether items like a strike will recur next year or not, and to decide whether a lease abandonment will recur or not. We need an all-inclusive statement with no extraordinary items. Let users apply the income statement for predictive purposes by eliminating items that will not recur. But let the record show all events that have an impact-there are really no values that don t count The current operating performance approach to reporting has no merit. I argue that everything is relevant and needs to be included. By omitting items from current operating performance, we are relegating them to a lesser role. I do not believe this is conceptually correct. We include everything to better evaluate management and forecast earnings. Users can individually decide on the merits of an in- ventory write-off or the planned sale or abandonment of a plant. Both items deserve to adversely affect income because they reflect management performance. Both items can be excluded by the user in forecasting earnings. The current system yields abuses. Even an earthquake is part of the picture. A lease abandonment recurs in the oil industry. No man is wise enough to cut the Gordian knot on this issue by picking and choosing what is extraordinary, recurring, typical, or customary. Required: a. Describe your views on this statement. What is your opinion on how extraordinary items should be reported? b. Discuss how extraordinary items should be treated in financial analysis. EXERCISE 11-3 Extraordinary Items in Financial Statement Analysis An analyst needs to understand the sources and implications of variability in financial state- ment data. Required: Identify factors affecting variability in earnings per share, dividends per share, and market price per share that derive from: a. The company. b. The economy. (CFA Adapted) EXERCISE 11-5 Identifying Sources of Variability in Financial Data