Jill Brown, CFA, is preparing a research report on Kendall Koatings, a maker of paint and industrial insulators. She has learned that Kendall is trying to avert a strike. Contentious labor talks have been ongoing for months. The company is also lobbying the federal government for a tax break in an effort to fend off foreign competition. Most Kendall executives own substantial blocks of stock, and all of them receive at least half of their compensation in the form of stock options. Lastly, one of Kendall’s lines of credit is up for renewal, and the company is trying to negotiate better terms. Several of Kendall’s top managers have a history of manipulating financial results. Based on her observations, which action is Kendall most likely to take? A) Recognize revenue early. B) Increase growth projections to unsustainable levels. C) Treat all leases as operating leases. D) Assume that equipment has a useful life of eight years, rather than the five years currently assumed. Your answer: B was incorrect. The correct answer was C) Treat all leases as operating leases. Kendall is negotiating a labor contract, seeking regulatory relief, and renegotiating credit terms. All actions are made easier if earnings are low. Executives are compensated with stock options, suggesting some pressure to boost earnings. But with three ongoing activities benefiting from lower earnings, it would seem that Kendall executives would be best served by understating earnings. With that in mind, treating all leases as operating leases will lower perceived leverage. Early revenue recognition and the lengthening of equipment lives will boost earnings. Growth projections will have no effect on earnings in the short run, though aggressive projections could provide an incentive for management to overstate earnings in the future.
wow … This as to be the question of the day, no doubt! Pinky - Which source are you doing the questions from??