Metalwise plc (Metalwise) is a company which purchases metals which it then processes into high-purity metals and alloys. Its shares are listed at the London Stock Exchange and it has a 31 December year-end. Metalwise plc uses International Financial Reporting Standards (IFRS) to prepare its financial statements.

Your role

You are employed in the accounting department at Metalwise. The financial controller is on long term sick leave and the CEO has asked you to finalise the financial statements of Metalwise for the year ended 31 December 2020.

The CEO gives you the following briefing note:

Draft summary statement of comprehensive income for the year ended 31 December 2020

			000
Revenue			617,000
Cost of sales			(450,000)
Gross profit			167,000
Operating expenses	See Exhibit 3		(120,761)
Operating profit			46,239
Finance costs			(6,500)
Profit before tax			39,739
Income tax expense (To be completed)
Profit for the year			39,739
Other comprehensive income (To be completed)			-
Total comprehensive income			39,739

Draft statement of financial position as at 31 December 2020

			000
ASSETS
Non-current assets
Property, plant and equipment (Exhibit 3 Issue 1)			100,000
Intangible			10,000
Investment (Exhibit 3 Issue 2)			8,000
			118,000
Current assets
Inventories			93,062
Trade receivables			35,035
Financial asset			50
Cash and cash equivalents			8,322
			136,469
Total assets			254,469
EQUITY AND LIABILITIES
Share capital and share premium			100,000
Retained earnings			65,339
Other reserves
			165,339
Long-term liabilities
Long-term bank borrowings			35,010
Deferred tax Balance at 1 January 2020 (Exhibit 3 Issue 3)			16,000
			51,010
Current liabilities
Trade and other payables			38,020
Current tax payable (Exhibit 3 Issue 3)			100
			38,120
Total equity and liabilities			254,469

Earning management

1. Metalwise grants a bonus of 10,000 to each employee of the accounting department if earnings per share (EPS = profit / number of shares outstanding) grow by at least 8% compared with the previous year. Based on the draft financial statements for the year ended 31 December 2020, EPS growth compared to the year ended 31 December 2019 is 6%. However, in the draft financial statements, you still have discretion among the current assets, i.e., you can revisit the financial controllers accounting choices and change them without violating the accounting rules. Required:Explain the incentive structure that the bonus contract creates and identify the target EPS growth that it sets for you as an employee of the accounting department. In addition, identify two specific examples of accounting choices that you would like to revisit in the draft financial statements and explain how you would change these accounting choices in order to achieve the target EPS growth.

2. Assume that an accounting researcher approaches you. The researcher studies earnings management and uses the Dechow and Dichev (2002) model to identify instances of earnings management. Required:Explain whether and, if so, how the accounting choices you consider in a) affect each component of the Dechow and Dichev (2002) model. You are not required to compute any specific values from the draft financial statements.