Question 1:
A common technique to manage earnings is to ‘stuff the channels’, that is, to ship prematurely to dealers and customers, thereby inflating sales for the period. A case in point is Bristol-Myers Squibb co. (BMS), a multinational pharmaceutical company head-quartered in New York. In August 2004, the Securities Exchange Commission (SEC) announced a USD 150 million penalty levied against BMS. This was part of an agreement to settle charges by the SEC that the company had engaged in a fraudulent scheme to inflate sales and earnings in order to meet analysts earnings forecasts.
According to the SEC, the company also engaged in ‘cookie jar’ accounting. That is, it created phony reserves for disposals of unneeded plants and divisions during high-profit quarters. These would be transferred to reduce operating expenses in low-profit quarters when BMS’ earnings still fell short of amounts needed to meet forecasts.
Required:
a. Using relevant academic papers, discuss the incentives why managers would resort to extreme earnings management technique such as this.
b. Critically evaluate the effectiveness of ‘stuffing the channels’ and ‘cookie jar accounting’ as earnings management devices. Consider both from the standpoint of a single year and over a series of years.
Question 2:
IAS 36 Impairment of Assets was published in 1998and subsequently amended in 2004 and in 2008. Its primary objective is to ensure that an asset is not carried on the statement of financial position (balance sheet) at a value that is greater than its recoverable amount.
Required:
a. Critically appraise the circumstances where an impairment loss is deemed to have occurred and explain when companies should perform an impairment review of assets.
b. Using recent assets impairment decision taken by PSA Peugeot Citroën and Vodafone as examples, discuss the effects of such decision on the firms’ financial position and performance.
