Sample Question 1

The following quotation appeared in the News section of AccountingEducation.com

(http://www.accountingeducation.com/news/news663.html).
The U.S. Securities Exchange Commission has asked accounting rule makers to tighten standards
governing the way Internet companies book their revenue. The SEC has displayed concern over these
companies, many of which are operating at a loss, which are found to be 'juicing up' their numbers by
including in their revenue figures the total revenues for product sales on behalf of other companies.
Correctly, they should only show in their revenue the distribution fees received for distributing the
products. Moreover, "free" services provided to customers are also booked as revenue as well as
barter transactions in which they exchange advertising with another Internet company. In the latter
case, an Internet company has typically reported revenue for one advertisement and a marketing
expense for the bartered advertisement, and the SEC has regarded this as an accounting abuse which
must be stopped.
Although the Financial Accounting Standards Board has postponed addressing these issues, the SEC
has asked for an emerging issues task force to address the problems.
Required:
Do you agree with the SEC that the practices described above are an accounting abuse which must be
stopped? Discuss the advantages and disadvantages of the current approach.
The student may agree or disagree that these practices are an abuse. A reason should be given for
the students position.
Advantages of the current approach:
- allows flexibility for management which can be used to reduce contracting costs
- better indication of business activity for this type of business -- indication of future potential
- allows high quality firms to signal by not engaging in such practices
Disadvantages of the current approach:
- inflates the revenues and expenses of a firm which distorts financial ratios and makes it more
difficult for users to interpret the financial reports
- revenue includes items that may not persist because of the nature of the business relationship
- i.e. acting as agent not as principal
- values assigned to barter transactions may not be reliable

Sample Question 2
The following quotations are taken from an article Restructuring sends Molson profit lower that
appeared in the November 3, 1999 edition of the Globe and Mail Report on Business.
Molson Inc., now restructuring its brewery operations, yesterday reported a profit of $4-million in the
second quarter, down from $30.8-million a year earlier.
Molson also reported a 28-per-cent increase in gross earnings before provision for rationalization,
interest, income taxes and amortization to $183.7-million for the six months ended Sept. 30 from
$143.5-million.
But profit for the six-month period dropped to $26.6.-million from $190.2-million. On the bright
side, the company noted a 14.5-per-cent improvement in brewing operating profit to $148.4-million
from $129.6-million.
Molsons management argues that the six month data an increase of 28 percent in gross earnings but a
major drop in profit (from $190.2-million to $26.6-million) is indicative of improvement in operations.
Required:
Use concepts from the course to explain why this is a reasonable argument.
- persistent earnings have increased
- ERC = (1 + Rf) / Rf
- the drop in earnings is a result of transitory items which will not persist in future periods
- ERC = 1
- since the earnings increase is persistent while the decrease is transitory, firm value and share
price should increase
- restructuring may be interpreted as a good news signal reflecting the fact that a problem area has
been addressed and hopefully corrected.

Sample Question 3
The following quotation is taken from an article titled TD to open up quarterly conference calls that
appeared in the January 22, 1999 Globe and Mail Report on Business.
Toronto-Dominion Bank broke new ground yesterday, announcing it will allow the media, and by
extension small investors who read the business pages, to listen into its quarterly conference calls
with financial analysts.
Required:
Comment upon the significance of the above quotation in terms of a topic or topics covered in this
course.
- allowing the media to listen to the conference calls improves the flow of information to small
investors (reduces information asymmetry) because it is not clear that financial analysts
distribute information equally to all current and potential investors
- will increase the efficiency of the market as the information will be more widely distributed
quickly
- protects the small investor by giving them access to information at almost the same time as the
analysts big customers - reduction of information asymmetry
- it is a voluntary disclosure
- may reduce the role of analysts in the distribution of financial information