Lehman Brothers: Sold toxic asset (i

1. 12. Lehman Brothers: Sold toxic asset (i.e., financial investments) to other banks with a buyback agreement, removing the toxic assets from its books.
   
   Identify how the B/S and earnings quality were impaired:

B/S quality: Firm appears more liquid than it actually is.

Earnings quality: Toxic assets should probably be reported at lower amounts on the B/S with associated changes to earnings.

2. 12. Saytam: Created fictitious revenue recognition journal entries.
   
   Identify how the B/S and earnings quality were impaired:

B/S quality: Current ratio/liquidity ratios are inflated by fictitious A/R.

Earnings quality: Earnings are overstated by the fradulent transaction, leading the public to believe profitability is higher.

3. 13. A company may try to paint a favorable picture of itself by accelerating the timing of revenues or estimating the collectible amounts too aggressively. In these cases the quality of accounting information declines because it does not represent the company's true economic condition and may not be sustainable. List two conditions which might suggest that a company is recognizing revenues too early?

Possible answers
1. Large and volatile amounts of uncollectible accounts receivable.
2. Unusually large amounts of returned goods.
3. Excessive warranty expenditures.
4. A significant increase in days accounts receivable are outstanding.

4. 14. Briefly define and give an example for accrual manipulation and real activities manipulation. What is the main difference b/w the two methods of manipulation?

Accrual manipulation: Changing accounting methods, estimations, delaying write-offs, etc. No effect on cash flows.

Real activities manipulation: Selling assets, cutting R&D expense, cutting advertising expense, etc. Has effect on cash flows.