1. 6. Which of the following is not considered a motive to manage earnings?
   a. To create optimal manager compensation payments.
   b. To create optimal job security for senior management.
   c. To create optimal measures of assets and liabilities for balance sheet purposes.
   d. To manage reported earnings in order to reduce industry-specific actions.

c. To create optimal measures of assets and liabilities for B/S purposes.

2. 7. One definition of earnings management is that it occurs when managers use:
   a. Judgement in financial reporting to alter financial reports to mislead stakeholders.
   b. an accounting method that is inconsistent w/ other industry members
   c. more conservative accounting estimates than other companies
   d. pro forma accounting results as opposed to GAAP results

a. judgment in financial reporting to alter financial reports to mislead stakeholders

3. 8. Earnings that are high quality would:

a. be informative about CURRENT performance and provide useful information about the long-run sustainability of PROFITS.

4. 9. Accounting information should provide a fair and complete representation about a number of a firm's characteristics. Which of the following is not one of those characteristics?
   a. Risk
   b. Position
   c. Performance
   d. Conservatism

d. Conservatism

5. 10. List two incentives that managers have to manage earnings upward?

1. to increase compensation payments under compensation contracts based on
earnings or stock prices.
2. to enhance job security for senior management by influencing the outcomes of
transactions that affect corporate control such as proxy fights and takeovers.
3. to obtain debt financing at a lower cost by appearing more profitable, to mitigate
potential violation of debt covenants, or to influence the effects of other
binding constraints from accounting-based contracts.
4. to influence short-term price performance and increase the economic benefits to
the firm from engaging in initial public offerings, seasoned equity offerings, and
share repurchases.
5. to influence stock prices positively (or delay stock price declines) by meeting or
beating the market's expectations for earnings, managers' own earnings forecasts,
and prior period's earnings.

6. 11. Provide two incentives that managers have to manage earnings downward

1. to discourage entry into the industry by potential competitors.
2. to reduce the probability of antitrust actions against the firm or other regulatory
interventions or political interference related to tax issues, capital requirements
(e.g., for banks, thrifts, and insurers), and import relief.
3. to maintain a smooth earnings time-series to appear less risky.
4. to obtain terms favorable to management in share repurchases or taking the firm
private.
5. It is also important to note that, when pressures to manage earnings upward are not
present, managers may manage earnings downward in order to create "cookie jar
reserves." These reserves are understatements of assets and overstatements of liabilities
that can be reversed in later periods to manage earnings upward. For example,
over-reserving for bad debt expense in the current period (downward earnings
management) permits under-reserving for bad debt expense in later periods.

7. 12. Waste Management: Falsely increased the useful lives of long-lived assets.
   
   Identify how the B/S and earnings quality were impaired:

B/S quality: impaired b/c public believes PP&E is newer than it is. Collateral value of PP&E is overstated.

Earnings quality: Firm appears more profitable than it is.

8. 12. Enron: Under-reported balance sheet long-term debt.
   
   Identify how the B/S and earnings quality were impaired:

B/S quality: Solvency risk ratios using some measure of long-term debt in the numerator incorrectly indicate lower solvency risk.

Earnings quality: If LT debt is incorrectly omitted from the B/S, interest expense will be omitted from the I/S.

9. 12. WorldCom: Capitalized rather than expensed expenditures to maintain transmission lines.
   
   Identify how the B/S and earnings quality were impaired:

B/S quality: similar to Waste Management

Earnings quality: Similar to Waste Management

10. 12. AIG: Booked debt as revenue.
    
    Identify how the B/S and earnings quality were impaired:

B/S quality: If debt is LT, solvency risk measures will indicate lower risk. If debt is ST, liquidity ratios will indicate lower risk.

Earnings quality: Seriously impaired. Earnings are overstated by the amount of the debt, leading public to believe profits are higher than they really are.