...Journal of Accounting and Economics 50 (2010) 344–401 Contents lists available at ScienceDirect Journal of Accounting and Economics journal homepage: www.elsevier.com/locate/jae Understanding earnings quality: A review of the proxies, their determinants and their consequences$ Patricia Dechow a, Weili Ge b, Catherine Schrand c,n a b c University of California, Berkeley, CA 94720, United States University of Washington, Seattle, WA 98195, United States University of Pennsylvania, Philadelphia, PA 19104, United States a r t i c l e i n f o abstract Available online 4 November 2010 Researchers have used various measures as indications of ‘‘earnings quality’’ including persistence, accruals, smoothness, timeliness, loss avoidance, investor responsiveness, and external indicators such as restatements and SEC enforcement releases. For each measure, we discuss causes of variation in the measure as well as consequences. We reach no single conclusion on what earnings quality is because ‘‘quality’’ is contingent on the decision context. We also point out that the ‘‘quality’’ of earnings is a function of the firm’s fundamental performance. The contribution of a firm’s fundamental performance to its earnings quality is suggested as one area for future work. & 2010 Elsevier B.V. All rights reserved. JEL classification: G31 M40 M41 Keywords: Earnings quality Earnings management Review Survey 1. Introduction Statement of Financial Accounting...
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...Chapter 5 Recognizing Expenditures in Governmental Funds Questions for Review and Discussion 1. Expenditures are decreases in net financial resources whereas expenses are reductions in overall net assets. Expenditures are governmental fund equivalents of expenses. In effect, expenditures are expenses that are determined on the modified rather than the full accrual basis of accounting. 2. Expenditures should be recognized on an accrual basis unless they qualify as one of the exceptions specifically set forth by the GASB. Utility costs are not such an exception and should thereby be recognized as an expenditure in the period in which the utility services are used. 3. Wages and salaries are accounted for on an accrual basis. The change would have no impact on reported expenditures under GAAP. The expenditure would be charged in the year in which the employees provided their services, irrespective of when they are paid. 4. Although governments must accrue the liability for compensated absences, they should report in governmental funds only the portion of the liability expected to be liquidated with expendable available financial resources. Correspondingly, they should charge, as an expenditure in governmental funds, only the amount that would be recorded as a governmental fund liability or paid during the period. This practice reflects the significance of the budget in governmental accounting. The government would have to budget (and levy taxes to pay for)...
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...Expenditures are governmental fund equivalents of expenses. In effect, expenditures are expenses that are determined on the modified accrual rather than the full accrual basis of accounting. 2. Expenditures should be recognized on an accrual basis unless they qualify as one of the exceptions specifically set forth by the GASB. Utility costs are not such an exception and should thereby be recognized as expenditures in the period in which the utility services are used. 3. Wages and salaries are accounted for on an accrual basis. The change would have no impact on reported expenditures under GAAP. The expenditure would be charged in the year in which the employees provided their services, irrespective of when they are paid. 4. Current standards state that vacation leave and other compensated absences with similar characteristics should be accrued as a liability as the benefits are earned by the employees if both of the following conditions are met: a. The employees’ rights to receive compensation are attributable to services already rendered. b. It is probable that the employer will compensate the employees for the benefits through paid time off or some other means, such as cash payments at termination or retirement. By contrast, sick leave need be accrued only to the extent that it will be paid as a termination benefit. The difference in accrual requirements is based on the degree of control over the absences. The employer and employee can control if...
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...Accrual Basis Accounting: Businesses Record Transactions as They Occur Abstract The purpose of this paper is to summarize the effects of accuracy and reliability of accrued expenses for financial information provided to users based on academic information. I will evaluate several key factors that are involved in accruing for expenses and how accruals affect a company’s financial statements. Included will be GAAP’s matching principle and FASB guidance on accruals. Other sources examined will from several academic articles. The results indicate that accruing for expenses maintain the matching concept. Accruals help avoid deceptive income statements that could result from the timing of cash payments. Table of Contents Abstract …………………………………………………………………………………...2 Table of Contents …………………………………………………………………………3 Introduction …………………………………………………………………………….....4 Literature Review ………………………………………………………………….. …......5 Locating Financial Misstatements: Where to Look……………………………....5 Accounting for the Costs to treat Environmental Contamination…………………7 Coping with FASB Statement No. 106-- "Accounting for Post-retirement Benefits Other Than Pensions…………………………………………………8 On the Implementation of Accrual Accounting: A Study of Conflict and Ambiguity……………………………………………………………………..8 Depreciation Rules and the Relation between Marginal and Historical Cost…….9 The Role of Accruals in Asymmetrically Timely Gain and Loss Recognition…...9 On Matching...
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...evidence and the proclamation of prosecutors, the action account department has taken was not following the GAAP. However, to the word of Richard himself, this way of accounting was not a really big deal like the WorldCom bankrupt or Enron bankrupt. And he is also very confident to continue developing his career in the future after he is released from the jail. 1. Sumarize the lessons learned by you from reading this article. The way that Computer Association records its sales has pointed out several accounting principles and concepts. According to the article, the account department recognized revenue while the contract was signed. It follows the accrual concept that revenue is recognized not only when cash transactions occur. Since the contracts were signed, the revenue could be received sooner or later. The accrual accounting helps to provide a more accurate picture of current company condition. However, Computer Association made an aggressive accounting strategy that some of the revenue of next quarter was recognized in the current quarter, which increases the revenue in the current quarter. Though the revenue of next quarter will decrease, the...
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...that his company should hold off on recording the loss until a settlement has been reached. A contingency is an existing situation dealing with the possibility of a loss or gain to a company that will be a result from future events failing to occur. The chances of winning the case are remote which means Camp Industries is not likely to win the law suit. According to the standards of financial accounting and reporting states “An estimated loss from a loss contingency shall be accrued by a charge to income if both of the following conditions are met: The amount of loss can be reasonably estimated and it is implicit in this condition that it must be probable that one or more future events will occur confirming the fact of the loss.” If no accrual is recorded for the contingency the financial statements could be very well misleading. A discloser should be made if the loss is estimated; if not then a discloser should be made stating that an estimate cannot be made. The ethical dilemma resulting from the case involves falsifying financial statements in order to avoid the documented disclosure of the loss from being exposed to the opposing party. This also is a creditability and integrity issue. No matter what a colleague suggests, you should always follow the current accounting standards. This could jeopardize your career as well as the creditability of Camp Industries in the eyes of stakeholders. Stakeholders are anyone or group that has interest in Camp Industries. Key stakeholders...
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...IMPORTANCE OF ADJUSTMENT ENTRIES Importance of Adjustment Entries Jourdain M. Yardan American Intercontinental University IMPORTANCE OF ADJUSTMENT ENTRIES ABSTRACT Adjustment entries are made to handle issues that occur from events that directly affect expenses and revenue for accounting periods. The four types of accounting entries are accrued revenues, unearned revenues, accrued expenses, and prepaid expenses. Input forms for the journal entries that have supported information for each transaction are used to record information into a computerized accounting system. Ethical issues come up in the world of adjustment entries therefore the necessity to have approved entries. Keywords: Adjustment Entries, Revenue, Transaction, Ethical, Accrued IMPORTANCE OF ADJUSTMENT ENTRIES Importance of Adjustment Entries Adjustment journal entries are made to adjust account balances and events that affect revenue and expenses for accounting periods. Since all transactions can be hard to annotate, adjustment entries are used to account for items that do not get recorded in daily transactions. There are multiple ways to complete adjustment entries such as hiring an accountant that will give you copies to enter into a general ledger or by simply completing it by yourself. Adjustment entries create complete and accurate...
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...Discussion1 Is Fast Eddie required to accrue a liability as of March 31, 2011, financial statements related to the ongoing government investigation? If so, how much? Yes. Fast Eddie is required to accrue a liability of $3.7 million. Subsequent Events are Events or transactions that occur after the balance sheet date but before financial statements are issued or are available to be issued. There are two types of subsequent events: a. The first type consists of events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements (that is, recognized subsequent events). b. The second type consists of events that provide evidence about conditions that did not exist at the date of the balance sheet but arose subsequent to that date (that is, nonrecognized subsequent events). According to ASC 855-10-25-1, an entity shall recognize in the financial statements the effects of all subsequent events that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. An example of recognized subsequent events is that if the events that gave rise to litigation had taken place before the balance sheet date and that litigation is settled after the balance sheet date but before the financial statements are issued or are available...
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...Case 1: Contingencies 1. For the year-end December 31, 2007, financial statements, what amount should M record as a liability? ASC 450-20-25-2 states that: An estimated loss from a loss contingency shall be accrued by a charge to income if both of the following conditions are met: a. Information available before the financial statements are issued or are available to be issued indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements. Date of the financial statements means the end of the most recent accounting period for which financial statements are being presented. It is implicit in this condition that it must be probable that one or more future events will occur confirming the fact of the loss. b. The amount of loss can be reasonably estimated. According to ASC 450-20-25-2, M International should accrue the liability for the loss contingency and disclose the liability within their year-end December 31, 2007 financial statements. ASC 450-20-30-1 determines what amount should be accrued and disclosed if both conditions are met in ASC 450-20-25-2. ASC 450-20-30-1 specifies that: If some amount within a range of loss appears at the time to be a better estimate than any other amount within the range, that amount shall be accrued. Therefore, M International should record the $17 million as the liability for the contingency because it is the most likely amount within the range of $15 million to...
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...From: Naz Date: 4/17/16 Re: Mighty Mufflers Corp. (MMC) Loss Contingencies Issues The complexity of MMC’s accounting for its litigation liability must be addressed in three components. First, we must determine the amount necessary to be accrued as of December 2012 from the First Settlement. Next, we must determine the placement of the aforementioned accrual from the First Settlement on the income statement. Finally, we must determine how to account for the True-Up Payment as of December 2012. In the First Settlement, MMC agreed to a total settlement of $30 million; $10 million of this is due in 2013, $10 million will be issued as a rebate on 2013 purchases made by plaintiffs, and the final $10 million will be due in 2014. There are seemingly few options, some of which are viable, in the accounting of the First Settlement. The options are to omit any recognition of the settlement since no payments were due in 2012 (but make a disclosure in the footnotes of the financial statements), accrue a portion of the $30 million on the balance sheet, or accrue the entire $30 million on the balance sheet. The aforementioned accrual, and the decision in how to recognize it as of December 2012, will impact the income statement. If no entry is made to accrue any amount from the First Settlement, there will be no effect on the income statement. If a portion or all of the First Settlement is accrued, then it can be recognized as an extraordinary loss on the income statement (so long as lawsuits...
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...use of the accruals basis 5.1 Government accounting Government accounting is the process of recording, analyzing, classifying, summarizing communicating and interpreting financial information about government in aggregate and in detail reflecting transactions and other economic events involving the receipt, spending, transfer, usability and disposition of assets and liabilities. The purposes of government accounting are: • To carry out the financial business of government in a timely, efficient and reliable manner (e.g. to make payments, settle liabilities, collect sums due, buy and sell assets etc.) subject to necessary financial controls. • To keep systematic, easily accessible accounting and documentary records as evidence of past transactions and current financial status, so that detailed transactions can be identified and traced and all aggregates can be conveniently broken down into their constituent parts. • To provide periodic financial statements, containing appropriately classified financial information, as a basis for (a) stewardship and accountability and (b) decision-making. • To maintain financial records suitable for budgetary control, internal control and the needs of auditors. • To provide means for effective management of government assets, liabilities, expenditures and revenues. In government, the producers of accounting information are rarely qualified accountants. Therefore few have experience of accrual accounting...
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...available at ScienceDirect Journal of Accounting and Economics journal homepage: www.elsevier.com/locate/jae Accrual-based and real earnings management activities around seasoned equity offerings Daniel A. Cohen 1, Paul Zarowin à New York University, Stern School of Business, NY 10012-1118, USA a r t i c l e i n f o abstract Article history: Received 15 January 2008 Received in revised form 22 December 2009 Accepted 18 January 2010 Available online 2 February 2010 We show that SEO firms engage in real activities manipulation, and the decline in postSEO performance due to the real activities management is more severe than that due to accrual management. Our evidence is important, because it shows that post-SEO operating underperformance is driven not just by accrual reversals, but also reflects the real consequences of operational decisions made to manage earnings. We also show how firms’ choices of real versus accrual-based earnings management activities around SEOs vary predictably as a function of the firm’s ability to use accrual management and the costs of doing so. & 2010 Elsevier B.V. All rights reserved. JEL Classification: G14 G32 M4 M41 Keywords: Seasoned equity offerings Earnings management Accounting choices Accounting Accruals Real activities 1. Introduction In this paper, we examine both real and accrual-based earnings management activities around seasoned equity offerings (SEOs). Prior research has documented that SEOs...
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...Suggested topics for discussions are provided for each question. Discussion need not be confined to the topics indicated. 1. In figure 5.1, the accounting cycle is illustrated. Explain the purpose and importance of each step in the cycle. Step 1 of the accounting cycle is to capture the data from every transaction involving the entity in the form of source documents, which may take many different formats. For example, source documents can consist of sales or service invoices, cash dockets, credit card slips, purchase invoices, delivery notes, credit notes, computerised cash register tapes, EFTPOS records. Step 1 is important in that it is the chief means of collecting data about the economic activities of the entity, which then must be recorded in the accounting system. The step provides a vital first stage in developing an audit trail for auditors to assess the effectiveness of control procedures in the accounting information system. Step 2 records (enters), in journals, all of the transactions about the entity from source documents developed in Step 1. This is usually done as a double entry process. The journals are important in that they provide a chronological record of the economic transactions and events that affect the entity. Step 3 posts all of the information from the journals into the entity’s ledger accounts. In so doing, financial information is reclassified into items of a like nature, i.e. into different types of assets, liabilities and equity...
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...decreases in net financial resources. Expenses are defined as outflows or expirations of assets or the incurrence of liabilities during a period. 2. Using the summary table at the end of chapter 5 as well as the more specific information within the chapter, explain how and when each of these expenses/expenditures would be reported in the fund statements and the government-wide statements prepared on Dec. 31, 2012. Assume all take place within the general fund. a) Using the accrual method your government determined that employees had earned a total of $25,000 unused vacation pay by the end of 2012. Of this amount, 60% would be used during the 2013 fiscal year. Vacation pay expense 25,000 Wages Payable 15,000 Accrued vacation pay 10,000 The leftover vacation pay from 2012 will be accrued to be paid in the next year and shown by the accrued vacation pay account. b) Pension expense totaled $100,000 for 2012 when computed according to FASB standards for accrual accounting. Your government has made payments into the plan totaling $100,000 this year. Pension expenditure 100,000 Pension liability 100,000 This shows the payment amount into the pension fund as based on actuarial determinations not merely the amounts contributed to the plans during the year or expected to be contributed shortly thereafter. c) In 2011 your government was involved in a law suit with a citizen. Your attorneys determined that it was probable that you would...
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...Question1 Two internal users of accounting information are Management and Employees. Management * For inspecting the association’s presentation and situation and taking apposite measures to progress the company effects. Employees * For investigating the feasibility and productivity of their speculation and decisive any upcoming course of achievement. Four external users of accounting information are Creditors, Investors, Customers, Regular Authorities. Creditors * For decisive the credit dullness of the association. Relations of credit are set by creditor rendering to the assessment of their customers monetary such as banks. Investors * For investigating the practicability of capitalizing in the company. Depositors want to make sure they can earn a sensible return on their investment before they obligate any financial capitals to the company. Customers * For evaluating the financial situation of its supplier which is essential for them to continue a constant source of supply in the long term. Regulatory Authorities * For certifying that the company’s revelation of accounting info is in agreement with the directions and protocols set in order to protect the interests of the stakeholders who trust on such material in forming their choices. Question2 i. Historical Cost * Is the value of a source given up or a liability acquired to obtain an asset/service at the time when the resource was given up or the liability experienced? ...
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