Income statement question

CFA Level I FRA
#1

So which statement is correct here?

I can’t really tell…But I am thinking the first one is correct?

Jerry Krome, CFA, is an equity analyst. The head of research at Krome’s firm composes a memo that contains the following statements:

  • To the extent that management has discretion over the firm’s revenue recognition, an analyst should consider policies that recognize revenue later to be more conservative than policies that recognize revenue sooner.
  • When comparing the performance of companies, an analyst can use the information in the financial statement disclosures to adjust the financial statements for differences in revenue recognition policies.

With regard to the implications of revenue recognition policies for financial analysis, Krome should agree with:

#2

The first answer should be correct. Deferring revenue, while recognizing the costs earlier (e.g. completed contract) is always conservative. The second answer is wrong because the financial statements do not contain enough detailed information to make reconciliation between different revenue recognition approaches. For this you’ll most probably need inside information.

Best, Oscar

#3

I would say the second one is true because a good-quality financial report has enough disclosures about mothods, approaches and policies related to income and expense recognition that the analyst is able to make the desired adjustments. Of course, we must assume the quality factor.

I agree with Oscar that inside information would allow a perfect adjustment of financial statements, but in real life the financial statements are indeed adjusted with the available information on them. A sound conclusion is that stocks with good-quality reports are likely to be traded at the most fair prices, while stocks with poor-quality reports are commonly priced below its true value (higher percieved risk, lower price, higher yield/return required).

Greetings!

#4

The first answer may be the way of tax evasion, or some another manner of creating reserves for further periods, not just conservative revenue recognition.

I would agree with Harrogath and vote for statement No. 2.

#5

wouldn’t the example of LIFO reserve make the second statement true? can both statements be correct? that’s my vote.

#6

They’re both true.

#7

What is LIFO reserve direct impact on revenue recognition? LIFO reserve has impact on COGS and thus on net income not on revenues.

#8

I

I believe you are right… so is statement 2 true?

#9

I would mark statement 2 as the correct one. S2000Magician says that Are both true and he is much more familiar with CFA program. :slight_smile:

#10

Both are true in my opinion.

First one is true because there is a conservative way to book revenues and an agressive way to do it. If a firm has policies that recognizes revenues later is said to be following a conservative revenue recognition policy.

The second one is correct because Annual reports do give a good idea about the policies a firm is using for example a depreciation method, a revenue recognition policy, aging of receivables, characterization of non performing loans. An analyst can make adjustments in order to compare two companies following different policies.