Metalwise plc (Metalwise) is a company which purposes 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.

Question 3 Earnings management (17 marks)

1. Metalwise grants a bonus of 7,000 to each employee of the accounting department if earnings per share (EPS = profit / number of shares outstanding) grows by at least 10% 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 12%. 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. In doing so, ignore the accounting issues discussed in Exhibit 3.

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 specific values from the draft financial statements.