Testbank

to accompany

Contemporary Issues in
Accounting

Michaela Rankin, Patricia Stanton,

Susan McGowan, Matthew Tilling,
Kimberly Ferlauto & Carol Tilt

Prepared by
Matt Tilling

John Wiley & Sons Australia, Ltd 2012

 Chapter 9 Earnings Management

Chapter 9 Earnings Management

Multiple Choice Questions

1. Earnings are important because:

a. Increased earnings signal an increase in equity value

b. Earnings are used to assess management performance
c. Earnings assist in predicting future cash flows
*d. All of the above

Correct answer: d
Learning Objective 9.1 ~Describe the importance of earnings in assessing the success of an
organisation.

2. Which of the following is NOT likely to be interested in earnings information

a. Shareholders
b. Lenders
c. Customers
*d. None of the above, i.e. they are all interested in earnings information

Correct answer: d
Learning Objective 9.1 ~Describe the importance of earnings in assessing the success of an
organisation.

3. Earnings management

a. Is illegal
b. Is considered to always be harmful to shareholders
*c. Has a range of meanings
d. None of the above

Correct answer: c
Learning Objective 9.2 ~ Explain what earnings management is.

4. With regards to inventory which of the following would be classed as conservative

accounting?

a. Being slow to write down slow-moving inventory

b. Still recording obsolete inventory as an asset
*c. Consistently and quickly applying the lower of cost and net realisable value
rule
d. Overstating inventory by including non-existent inventory in accounts.

Correct answer: c
Learning Objective 9.2 ~ Explain what earnings management is.

John Wiley & Sons Australia, Ltd 2012 9.1

Testbank to accompany Contemporary Issues in Accounting

5. Which of the following would be considered fraudulent accounting?

a. Recognising revenue when services are prepaid but only partially performed
*b. Capitalising advertising costs
c. Liberal credit terms and estimation of provision for doubtful debts
d. Restating useful life and residual value of non-current assets upwards

Correct answer: b
Learning Objective 9.2 ~ Explain what earnings management is.

6. Which of the following methods is NOT commonly used to manipulate earnings:

a. Accounting policy choice

b. Accelerating expenses
*c. Incorrect classification of current liabilities as non-current
d. Aggressive accounting for accruals

Correct answer: c
Learning Objective 9.3 ~ Describe a number of common methods of earnings management,
including accounting policy choice, accrual accounting, income smoothing, real activities
management and big bath write-offs.

7. An entity can change its accounting policy:

*a. Provided it can argue that the new method provides better information for
users
b. Only with the approval of its auditors
c. Never once the decision is made
d. As often as it likes

Correct answer: a
Learning Objective 9.3 ~ Describe a number of common methods of earnings management,
including accounting policy choice, accrual accounting, income smoothing, real activities
management and big bath write-offs.

8. Which of the following is NOT an accrual accounting technique that could be used to
manage earnings?

a. Under-provisioning for bad debts

b. Delaying asset impairments
c. Adjusting closing inventory valuations
*d. None of the above, they could all be used to manage earnings

Correct answer: d
Learning Objective 9.3 ~ Describe a number of common methods of earnings management,
including accounting policy choice, accrual accounting, income smoothing, real activities
management and big bath write-offs.

John Wiley & Sons Australia, Ltd 2012 9.2

 Chapter 9 Earnings Management

9. Which of the following techniques is NOT generally useful to smooth income

a. Varying the provision for warranties

b. Hedging of financial instruments
*c. Using fair value accounting
d. None of the above, they could all be used to smooth income

Correct answer: c
Learning Objective 9.3 ~ Describe a number of common methods of earnings management,
including accounting policy choice, accrual accounting, income smoothing, real activities
management and big bath write-offs.

10. Which of the following is NOT an example of real activities management that could
be used to manage earnings?

a. Reducing discretionary spending

*b. Adjusting loan loss provisions
c. Accelerating sales
d. Delaying research and development

Correct answer: b
Learning Objective 9.3 ~ Describe a number of common methods of earnings management,
including accounting policy choice, accrual accounting, income smoothing, real activities
management and big bath write-offs.

11. Big bath accounting is generally used to drop earnings when

a. There is a change in management team

b. When operations are restructured
c. When the economy is poor
*d. All of the above

Correct answer: d
Learning Objective 9.3 ~ Describe a number of common methods of earnings management,
including accounting policy choice, accrual accounting, income smoothing, real activities
management and big bath write-offs.

12. Which of the following earning management reasons would NOT be viewed as a
positive for shareholders?

a. To accurately convey private information

*b. To increase short term profits
c. To meet analysts' expectations
d. To avoid violating debt covenants

Correct answer: b
Learning Objective 9.4 ~ Explain why entities manage earnings.

John Wiley & Sons Australia, Ltd 2012 9.3

Testbank to accompany Contemporary Issues in Accounting

13. Why does income smoothing generally lead to a higher share value?

*a. It reduces the perceived risk of the company

b. It leads to higher perceived income
c. It is perceived as increasing the chance of insolvency
d. None of the above

Correct answer: a
Learning Objective 9.4 ~ Explain why entities manage earnings.

14. Which of the following is NOT thought to reflect earnings quality?

a. Trend in profit results

*b. Total income tax expense for the period
c. Operating/non-operating mix
d. Earnings base

Correct answer: b
Learning Objective 9.4 ~ Explain why entities manage earnings.

15. Research into income smoothing has concluded that

a. Smoothed income indicates high earnings quality

b. Smoothed income indicates low earnings quality
*c. The findings are mixed with regards to earnings quality
d. There is no relationship between income smoothing and earnings quality

Correct answer: c
Learning Objective 9.4 ~ Explain why entities manage earnings.

16. Which of the following components of managerial compensation are thought to most
encourage earnings management

a. Their base salary

*b. Their cash bonuses
c. Shares or share options
d. Various perquisites

Correct answer: b
Learning Objective 9.4 ~ Explain why entities manage earnings.

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 Chapter 9 Earnings Management

17. Which of the following is most likely to be true

a. An existing CEO facing removal is likely to manage earnings downwards

b. An incoming CEO following a forced departure will find it easier to manage
earnings upwards
*c. An incoming CEO would prefer to manage earnings downward in their first
year
d. None of the above

Correct answer: c
Learning Objective 9.4 ~ Explain why entities manage earnings.

18. Researchers examining share price reactions to evidence of fraudulent reporting have
concluded that:

a. Markets are highly efficient

b. Markets interpret the discovery as good news
*c. Markets are generally surprised by the information
d. Share prices are generally unaffected

Correct answer: c
Learning Objective 9.5 ~ Identify the consequences of earnings management.

19. Research into IPOs and earnings management have indicated:

*a. Investors expect upwards earning management

b. Firms do not engage in upwards earnings management
c. The market does discover upwards earning management
d. None of the above

Correct answer: a
Learning Objective 9.5 ~ Identify the consequences of earnings management.

20. Which of the following board characteristics are likely to reduce earnings
management

a. A mix of monitoring and expertise skills

b. More independent directors
c. The existence of an audit committee
*d. All of the above

Correct answer: d
Learning Objective 9.6 ~ Assess the role corporate governance plays in controlling earnings
management.

John Wiley & Sons Australia, Ltd 2012 9.5