Chapter 1
Ethics Insight: Dewey & LeBoeuf LLP
Q: Why did these employees lie, and what do you believe should be their penalty for these lies?
A: They felt pressured by their supervisors to make the company’s financial statements look better than warranted. They should be prosecuted for fraudulent activities under the Sarbanes-Oxley Act, as they knowingly misstated financial statement data.
People, Planet, and Profit Insight
Q: Why might a company’s stockholders be interested in its environmental and social performance?
A: Many companies now recognize that being a socially responsible organization is not only the right thing to do, but it also is good for business. Many investment professionals understand, for example, that environmental, social, and proper corporate governance of companies affects the performance of their investment portfolios. For example, British Petroleum’s oil spill disaster is a classic example of the problems that can occur for a company and its stockholders. BP’s stock price was slashed, its dividend reduced, its executives replaced, and its reputation badly damaged. It is interesting that socially responsible investment funds are now gaining momentum in the marketplace such that companies now recognize this segment as an important investment group.
Chapter 2
Investor Insight: Chicago Cubs
Q: Do you think that the Chicago Bears football team would be likely to have the same major revenue and expense accounts as the Cubs?
A: Because their businesses are similar—professional sports—many of the revenue and expense accounts for the baseball and football teams might be similar.
Ethics Insight: Credit Suisse Group
Q: What incentives might employees have had to overstate the value of these investment securities on the company’s financial statements?
A: One reason that they may have been reluctant to record the losses is out of fear that the company’s shareholders and clients would panic if they saw the magnitude of the losses. However, personal self-interest might have been equally to blame—the bonuses of the traders were tied to the value of the investment securities.
Investor Insight: Fannie Mae
Q: In order for these companies to prepare and issue financial statements, their accounting equations (debits and credits) must have been in balance at year-end. How could these errors or misstatements have occurred?
A: A company’s accounting equation (its books) can be in balance yet its financial statements have errors or misstatements because of the following: entire transactions were not recorded; transactions were recorded at wrong amounts; transactions were recorded in the wrong accounts; transactions were recorded in the wrong accounting period. Audits of financial statements uncover some but obviously not all errors or misstatements.
Chapter 3
Ethics Insight: Krispy Kreme
Q: What motivates sales executives and finance and accounting executives to participate in activities that result in inaccurate reporting of revenues?
A: Sales executives typically receive bonuses based on their ability to meet quarterly sales targets. In addition, they often face the possibility of losing their jobs if they miss those targets. Executives in accounting and finance are very aware of the earnings targets of Wall Street analysts and investors. If they fail to meet these targets, the company’s stock price will fall. As a result of these pressures, executives sometimes knowingly engage in unethical efforts to misstate revenues. As a result of the Sarbanes-Oxley Act, the penalties for such behavior are now much more severe.
People, Planet, and Profit Insight
Q: What accounting issue might this cause for companies?
A: The balance sheet should provide a fair representation of what a company owns and what it owes. If significant obligations of the company are not reported on the balance sheet, the company’s net worth (its equity) will be overstated. While it is true that it is not possible to estimate the exact amount of future environmental cleanup costs, it is becoming clear that companies will be held accountable. Therefore, it seems reasonable to accrue for environmental costs. Recognition of these liabilities provides a more accurate picture of the company’s financial position. It also has the potential to improve the environment. As companies are forced to report these amounts on their financial statements, they will start to look for more effective and efficient means to reduce toxic waste and therefore reduce their costs.
Chapter 4
People, Planet, and Profit Insight: Regaining Goodwill
Q: Name two industries today which are probably rated low on the reputational characteristics of “being trusted” and “having high ethical standards.”
A: Two possible industries are financial companies (Goldman Sachs or AIG) or oil companies (BP).
Chapter 5
Investor Insight: Morrow Snowboards, Inc.
Q: If a perpetual system keeps track of inventory on a daily basis, why do companies ever need to do a physical count?
A: A perpetual system keeps track of all sales and purchases on a continuous basis. This provides a constant record of the number of units in the inventory. However, if employees make errors in recording sales or purchases, or if there is theft, the inventory value will not be correct. As a consequence, all companies do a physical count of inventory at least once a year.
People, Planet, and Profit Insight: PepsiCo
Q: What is meant by “monetize environmental sustainability” for shareholders?
A: By marketing green, not only does PepsiCo help the environment in the long run, but it also leads to long-term profitability as well. In other words, sound sustainability practices are good business and lead to sound financial results.
Ethics Insight: IBM
Q: Why have investors and analysts demanded more accuracy in isolating “Other gains and losses” from operating items?
A: Greater accuracy in the classification of operating versus nonoperating (“Other gains and losses”) items permits investors and analysts to judge the real operating margin, the results of continuing operations, and management’s ability to control operating expenses.
Chapter 6
Ethics Insight: Leslie Fay
Q: What effect does an overstatement of inventory have on a company’s financial statements?
A: The balance sheet looks stronger because inventory and retained earnings are overstated. The income statement looks better because cost of goods sold is understated and income is overstated.
International Insight: ExxonMobil Corporation
Q: What are the arguments for and against the use of LIFO?
A: Proponents of LIFO argue that it is conceptually superior because it matches the most recent cost with the most recent selling price. Critics contend that it artificially understates the company’s net income and consequently reduces tax payments. Also, because most foreign companies are not allowed to use LIFO, its use by U.S. companies reduces the ability of investors to compare U.S. companies with foreign companies.
Chapter 7
People, Planet, and Profit Insight
Q: Why is sustainability information important to investors?
A: Investors, customers, suppliers, and employees want more information about companies’ long-term impact on society. There is a growing awareness that sustainability issues can affect a company’s financial performance. Proper reporting on sustainability issues develops a solid reputation for transparency and provides confidence to shareholders.
Ethics Insight
Q: How can companies reduce the likelihood of fraudulent disbursements?
A: To reduce the occurrence of fraudulent disbursements, a company should follow the procedures discussed in this chapter. These include having only designated personnel sign checks; having different personnel approve payments and make payments; ensuring that check-signers do not record disbursements; using prenumbered checks and matching each check to an approved invoice; storing blank checks securely; reconciling the bank statement; and stamping invoices PAID.
Investor Insight
Q: How was Madoff able to conceal such a giant fraud?
A: Madoff fabricated false investment statements that were provided to investors. In addition, his auditor never verified these investment statements even though the auditor issued an unqualified opinion each year.
Chapter 8
Ethics Insight
Q: How might investors determine that a company is managing its earnings?
A: If the balance sheet reflects an increase in Accounts Receivable and a decrease in the Allowance for Doubtful Accounts, this could indicate an attempt to manage earnings by reducing the estimated uncollectible percentage.
Chapter 9
People, Planet, and Profit Insight: BHP Billiton
Q: Why do you believe companies issue sustainability reports?
A: It is important that companies clearly describe the things they value in addition to overall profitability. Most companies recognize that the health, safety, and environmental protections
of their workforce and community are important components in developing strategies for continued growth and longevity. Without a strong commitment to the principles of corporate social responsibility, it is unlikely that a company will be able to maintain long-term stability and profitability. The development of a sustainability report helps companies to consider these issues and develop measures to assess whether they are meeting their goals in this area.
Chapter 10
Investor Insight
Q: What are the advantages for companies of issuing 30-years bonds instead of 5-year bonds?
A: The major advantages for companies are to extend their debt and to pay low interest rates. This locks in these low rates for a considerable period of time.
People, Planet, and Profit Insight: Unilever
Q: Why might standardized disclosure help investors to better understand how proceeds from the sale or issuance of bonds are used?
A: By requiring transparency as to how a bond’s proceeds are to be used and how it will affect a company’s sustainable profitability, investors will make better financial decisions.
Investor Insight
Q: How can financial ratios such as those covered in this chapter provide protection for creditors?
A: Financial ratios such as the current ratio, debt to assets ratio, and times interest earned provide indications of a company’s liquidity and solvency. By specifying minimum levels of liquidity and solvency, as measured by these ratios, a creditor creates triggers that enable it to step in before a company’s financial situation becomes too dire.
Chapter 11
Investor Insight: Nike
Q: For stocks traded on organized exchanges, how are the dollar prices per share established?
A: The dollar prices per share are established by the interaction between buyers and sellers of the shares.
Investor Insight: Berkshire Hathaway
Q: Why does Warren Buffet usually oppose stock splits?
A: Buffett prefers to attract shareholders who will make a long-term commitment to his company, as opposed to traders who will only hold their investment for a short period of time. He believes that a high stock price discourages short-term investment.
People, Planet, and Profit Insight
Q: Why are CSR-related shareholder proposals increasing?
A: The increase in shareholder proposals reflects a growing belief that a company’s social and environmental policies correlate strongly with its risk-management strategy and ultimately its financial performance.
Chapter 12
Investor Insight
Q: Why is the fluctuating value of bonds a concern if a company intends to hold them until maturity?
A: If a company has to sell its investment in bonds before maturity, the sale proceeds may be substantially less than the original purchase price, due to rising interest rates, thus causing an investment loss.
Investor Insight
Q: What are arguments in favor of and against fair value accounting for loans and receivables?
A: Using fair value accounting for loans and receivables would provide a more realistic depiction of company’s financial position. However, fair value accounting could also cause significant swings in a company’s net income, due to unrealized gains and losses.
Chapter 13
N/A
Chapter 14
Investor Insight
Q: How might management influence a company’s current ratio?
A: Management can affect the current ratio by speeding up or withholding payments on accounts payable just before the balance sheet date. Management can alter the cash balance by increasing or decreasing long-term assets or long-term debt, or by issuing or purchasing common stock.
Investor Insight: Cisco Systems
Q: What incentive do companies have to report pro forma income?
A: The incentive is to make the company’s profitability look better. If GAAP generated net income is low or a loss, by excluding unusual or nonrecurring items, a company can improve its reported profitability.
Chapter 15
Management Insight: Louis Vuitton
Q: What are some of the steps that this company has taken in order to ensure that production meets demand?
A: The company has organized flexible teams, with jobs arranged by the amount of time a task takes. Employees now are multiskilled, so they can switch between tasks and products. Also, the stores now provide sales data more quickly to the manufacturing facility, so that production levels can be changed more quickly in response to demand.
Management Insight: Whirlpool
Q: In what ways does the shift to automated factories change the amount and composition of product costs?
A: As factories become more automated, they become more efficient, increasing output and decreasing cost per unit. The composition of those costs also switches: Factory labor costs decline, and factory overhead costs (e.g., depreciation and maintenance on equipment) increase.
Service Company Insight: Allegiant Airlines
Q: What are some of the line items that would appear in the cost of services provided schedule of an airline?
A: Some of the line items that would appear in the cost of services provided schedule of an airline would be fuel, flight crew salaries, maintenance wages, depreciation on equipment, airport gate fees, and food-service costs.
People, Planet, and Profit Insight: Phantom Tac
Q: What are some of the common problems for many clothing factories in developing countries?
A: Some of the common problems for many clothing factories in developing countries would be pressure to produce goods faster, lack of training for workers, unsafe buildings, substandard work conditions, and wage and labor violations. These problems can be exacerbated by the fact that many young women in developing countries are willing to accept low wages and working conditions that Americans consider unsafe because factory jobs offer them an opportunity to have a life that is better than that available in their villages.
Chapter 16
Management Insight
Q: What type of costs do you think the company had been underestimating?
A: It is most likely that the company failed to estimate and track overhead. In a highly diversified company, overhead associated with the diesel locomotive jobs may have been “lost” in the total overhead pool for the entire company.
Management Insight: iSuppli
Q: What type of costs are marketing and selling costs, and how are they treated for accounting purposes?
A: Product costs include materials, labor, and overhead. Costs not related to production, such as marketing and selling costs, are period costs which are expensed in the period that they are incurred.
Service Company Insight
Q: Explain why GE would use job order costing to keep track of the cost of repairing a malfunctioning engine for a major airline.
A: GE operates in a competitive environment. Other companies offer competing bids to win service contracts on GE’s airplane engines. GE needs to know what it costs to repair engines, so that it can present competitive bids while still generating a reasonable profit.