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THE VISIBILITY CORPORATION (TVC)
DELVIGNE Anne-CharlotteNGUYEN Linh
NICOSIA CalogeroVANCUTSEM Sbastien
YANOGO W. Mickael
ZENNER Gilbert
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CONTENT
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Directors ofThe Visibility Corporation (TVC) are
meeting to discuss whether the CEO should beoffered a new contract.
The CEO could have engaged in aggressiveaccounting system (known as earningmanagement).
Our objective is to examine the financial report (in
INTRODUCTION
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Earnings Management
Strategy used by the management of the company tomanipulate the companys earning and match a pre-determinated target (i.e profit for the year did not fall by morethan 510%).
Objectives:
To influence the perception of stakeholders about the firmsgeneral economic performance.
Influence certain outcomes that depends on reported
Question 1. What is meant by the term earningsmanagement? Give an example.
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Earnings Management
Strategy used by the management of the company tomanipulate the companys earning and match a pre-determinated target (i.e profit for the year did not fall by morethan 510%).
Objectives:
To influence the perception of stakeholders about the firmsgeneral economic performance.
Influence certain outcomes that depends on reported
Question 1. What is meant by the term earningsmanagement? Give an example.
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Example of earnings management
There are four main ways managers can manage earnings:
1) Unsuitable revenue recognition.2) Inappropriate accruals and estimation of liabilities.
3) Excessive provisions and generous reserve accounting.4) Intentional minor breaches of financial reporting requirements.
Suppose a business has an investment of 1 million at historiccost which can easily be sold for 3 million, being the currentvalue. The managers of the business are free to choose in
Question 1. What is meant by the term earningsmanagement? Give an example.
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Recall about the bookkeeping of the available-for-sale :
v Available-for-sale investments are measured at fair valuein the balance sheet.
v The change in the fair value susbequent to acquisition isrecognized directly in equity.
v Once AFS is sold, the amount previously reported inequity is then recycled out of equity and reported in
Question 2 : Describe how available-for-saleinvestments can be used for earningsmanagement under IFRS ( IAS No. 39)
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The manager can arrange when to recognize the gains or losses
of these available-for-sale investments by selling them inselective timing.
If the income statement need a boost: Sell AFS assets.Profits will be reported to the income statement.
If the income statement looks good: Keep AFS assets anddelay any recognition until losses occur.
Earnings management can be conducted by the manipulation offair value it can be over-estimated in case of profit or under-estimated in case of losses
Question 2 : Describe how available-for-saleinvestments can be used for earningsmanagement under IFRS ( IAS No. 39)
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Available-for-sale investments are reported
at fair value.
Question 4-a. Are available-for-sale investmentsreported in the balance sheet at fair value or cost?
Selected Notes to the Financial Statements
(1B) Investments
[] Available-for-sale investments are stated at fairvalue, with any resultant gain or loss being initiallyrecognized in equity. The amount is recognized in theincome statement in the period the available-for-saleinvestments are sold [].
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Income Statement:
Question 4-b. How much profit (loss) fromavailable-for-sale investments is reported in profitfor the year?
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A profit of$15 million is reported in the Income
Statement.
Question 4-b. How much profit (loss) fromavailable-for-sale investments is reported in profitfor the year?
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Question 4-c. How much profit (loss) fromavailable-for-sale investments is reported in totalrecognized income and expense for the year?
Total recognized income andexpense
=Profit
+Net income recognized in equity
172=
117+55 Recycledprofit of $
15 million
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AFL investments information given in thefinancial statements:
Question 4-d. Explain your answer to parts (b) and(c) above and the impact on current and futureprofits.
Balance Sheet
Cash FlowStatement
Statement ofChanges in Equity
AFL investments at 30 June 20X5: $ 30
Purchase of AFL investments: $ 40Proceeds from AFL investments: $ 20
Unrealized losses: $ 35.Profit reclassified to Income Statement:$ 15 (Other income).
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Year Accounts and Explanation Debit Credit
20X4
Available-for-sale assets 15
Reserves (Unrealized gain) 15
Question 4-d. Explain your answer to parts (b) and(c) above and the impact on current and futureprofits.
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Year Accounts and Explanation Debit Credit
20X4
Available-for-sale assets 15
Reserves (Unrealized gain) 15
20X5Available-for-sale assets 40
Cash 40
Question 4-d. Explain your answer to parts (b) and(c) above and the impact on current and futureprofits.
Reported in Cash Flow Statement.
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Year Accounts and Explanation Debit Credit
20X4
Available-for-sale assets 15
Reserves (Unrealized gain) 15
20X5Available-for-sale assets 40
Cash 40
20X5
Cash 20Reserves 15
Available-for-sale assets 20Profit 15
Question 4-d. Explain your answer to parts (b) and(c) above and the impact on current and futureprofits.
Reported in Cash Flow Statement
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Year Accounts and Explanation Debit Credit
20X4
Available-for-sale assets 15
Reserves (Unrealized gain) 15
20X5Available-for-sale assets 40
Cash 40
20X5
Cash 20Reserves 15
Available-for-sale assets 20Profit 15
Question 4-d. Explain your answer to parts (b) and(c) above and the impact on current and futureprofits.
Reclassified to the Income Statement.
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Year Accounts and Explanation Debit Credit
20X4
Available-for-sale assets 15
Reserves (Unrealized gain) 15
20X5Available-for-sale assets 40
Cash 40
20X5
Cash 20Reserves 15
Available-for-sale assets 20Profit 15
20X5
Reserves (Unrealized losses) 35
Available-for-sale assets 35
Question 4-d. Explain your answer to parts (b) and(c) above and the impact on current and futureprofits.
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Question 4-d. Explain your answer to parts (b) and(c) above and the impact on current and futureprofits.
Impact on current and future profits:
Current profit is a gain of $ 15 million.
If the company decide to sell the AFL assets,the unrealized losses will become realized andreported in the Income statement.
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Year Accounts and Explanation Debit Credit
20X4
Available-for-sale assets 15
Reserves (Unrealized gain) 15Total available-for-sale assets at 30 June
20X4: X.
20X5
Available-for-sale assets 40Cash 40
Total available-for-sale assets afterpurchase: X + 40.
20X5
Cash 20
Reserves 15Available-for-sale assets 20Profit 15
Total available-for-sale assets: X + 40 - 20= X + 20.
20X5
Reserves (Unrealized losses) 35
Available-for-sale assets 35Total available-for-sale assets at 30 June
20X5: X + 20 - 35 = X - 15.
Question 4-e. What was the amount of available-for-sale investments held at 30 June 20X4?
AssumeX(million $) is thevalue of AFLinvestments at30 June 20X4.
X = 30 + 15= 45.
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We believe the firm could have engaged in earningsmanagement but it is not possible to determine fromthe information given.
Question 5. Based on your answers to Question 4, do you thinkTVCs executives have engaged in earnings management?Give reasons for your answer, and identify any additionalinformation you require to reach a firm conclusion
Additional information required: Criteria for evaluating performance (i.e. earnings
must not exceed 10%): Possible incentives forearnings management.
Accounting policies of TVC: Who is responsible forpreparing and auditing the financial statements?
Information of transactions involving AFLinvestments: When and how were the AFLinvestments sold?
System of fair-value measurements: How was fair-
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Both measures are important.
Profit:To know the performance of annual
business cycle.
Changes in equity:To know the financialpositions of the firms and how the resources areused.
Another measure is ratio analysis: Calculatingratios based on data given by financial
statements.
Question 6: Should the performance be assessedon profit or changes in equity, as suggested byDavid, or on some other measure? Why?
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The information given is not sufficient to decide whetherto renew PBs contract.
It is important to find out whether PB has engaged in
earnings management, and re-evaluate theperformance of the company.
Additional information required:
Reconciliation of changes in equity: Ratio of profitfrom core operations to profit from secondarysources.
Ratio analysis (benchmarked with previous years, orcompetitors in the industry).
Question 7. What (if any) further information wouldyou like to have before deciding whether to renew PBscontract? What decision do you think Ann, Phil, andDavid should reach?
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CONCLUSION
Through the case study, we have explored the concept
of earnings management, available-for-sale investmentsand International Financial Reporting Standards(IFRS).
It is possible that TVCs executives have engaged in
earnings management, however the information given isnot sufficient to evaluate this.
Making financial reports more informative for usersthrough the use of accounting judgment should not be
considered as earnings management.
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Thank you for yourattention!