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30 Minutes, Strong
a.
CASE 12.3
USING EARNINGS PER SHARE STATISTIC
S
The company reports earnings per share computed on both a basic and a diluted basis
because it has outstanding convertible preferred stock. The conversion of these securities
35 Minutes, Strong
a.
shares)
throughout the year
Book value per share: Divide by the actual number of shares outstanding as of the specific
date (usually a balance sheet date)
CASE 12.
4
INTERPRETING A STATEMENT O
F
STOCKHOLDERS' EQUIT
Y
Beginning of year: 77,987,500 shares outstanding (82,550,000 issued 4,562,500 held in
treasury)
End of year: 77,353,100 shares outstanding (82,550,000 issued 5,196,900 treasury
60 Minutes, Strong
a.
3.
4.
d.
CASE 12.5
An asset represents something with future economic benefit. But if the amount at which the
asset is presented in the balance sheet (i.e., its book value) cannot be recovered through
future use or sale, any future economic benefit appears to be less than the asset’s current
book value. In such cases, the asset should be written down to the recoverable amount.
CLASSIFICATION OF UNUSUAL ITEMS
—
AND THE POTENTIAL FINANCIAL IMPACT
Extraordinary items are deducted after the determination of Income from Continuing
Operations. Therefore, this subtotal will be reduced only if the losses are classified as
ordinary.
Given that these losses do not affect income taxes, they have no cash effects. Therefore,
net cash flow from operating activities will be unaffected.
The p/e ratio is based upon income before extraordinary items (stated on a per-share basis).
g.
creating an introductory level textbook assignment, and the so-called quotations from corporate
officers are entirely fictitious. Nonetheless, we believe that the outcome of the actual event
provides insight into the financial reporting process and also to the importance that investors
attach to the various computations of earnings per share.
Management originally classified the losses as extraordinary, and the auditors concurred. The
figures and the announcement that substantial losses would be reclassified.
no book value, future earnings from these operations will not be reduced by charges for
depreciation (or, in some cases, for a cost of goods sold).
The ethical dilemma is the classification of these losses. Because of the probable effects upon
stock price, classifying them as extraordinary may be to management’s advantage. The case
is arguable—though we think it’s a bit of a reach. Bear in mind that a higher stock price also
CASE 12.5
CLASSIFICATION (continued
)
The classification of these losses may well affect Elliot-Cole’s stock price. Investors consider
income from continuing operations a predictive subtotal. If the losses are classified as
ordinary, this key subtotal will decline, probably below last year’s level. (The losses amount
financial press will rise significantly above its normal level. This, too, may have a depressing
effect upon stock price. But if the losses are classified as extraordinary, the per-share
earnings used in the computation of the company’s p/e ratio will not be affected.
30 Minutes, Medium
The fact that sales are sluggish but net income is steadily increasing at least raises an issue that
A possible explanation that is at least worth exploring is whether management has taken
conscious steps to overstate inventory. The motivation would be to increase reported net income
to enhance the position of management. The relationship of inventory to net income is as follows:
CASE 12.6
MANAGING PROFITABILIT
Y
This case is tended to encourage students to think about how certain financial statement numbers
should ordinarily be expected to move in relation to other numbers (e.g., net income in
comparison with sales) and steps that might be taken by management to manage, or manipulate
profitability. While there may be logical reasons for the specific changes identified in three
bulleted items in the case statement that do not imply improper actions by management, the fact
that their evaluation is, at least in part, based on profit performances raised an important issue
that should be kept in mind by auditors.
We do not attempt in this solution to write the report that is required in the instructions in the
case, but rather to provide some ideas of how students might respond to each of the bulleted
items.
Relationship of sales revenue and net income
The case statement indicates that it is particularly important for Flexcom, Inc. to control its
inventory because of the highly competitive market in which they operate and the sensitivity of
inventory to changes in consumer demand and technology changes. This sounds as if competition
and technological obsolescence are particularly important risks that Flexcom must control in
order in order to be successful. Rapidly rising inventory levels could be explained several
declined raises an interesting question that is worthy of further exploration.
ETHICS, FRAUD & CORPORATE GOVERNANC
E
CASE 12.6
MANAGING PROFITABILITY (concluded
)
Reduction in allowance for inventory obsolescence
The allowance to reduce inventory for obsolescence functions much as an allowance for
30 Minutes, Medium
STOCKHOLDERS' EQUITY AND EPS
CASE 12.7
INTERNET
The following answers are based on information from March 22, 2013 (part a.) and
2012 annual financial statements for the remaining parts.
a. On March 22, 2013, Martin Marietta's stock sold for a high of $103.92 and a low of
$102.50. These amounts will vary for other dates.
b. The number of shares of common stock outstanding on Dec. 31, 2012 was
46,002,000. These shares were originally sold by the company for the total of the par
value of the shares plus the additional paid-in capital:
