Question

As Surfboard Co. fiscal year-end was nearing, the CFO presented the CEO expected financial statement results for the year. The after-tax operating income (OI) was to be $43.7 million resulting in a return on beginning-of-period net operating assets (NOA) of 19.0 percent. “This won’t do!,” declared the CEO. “The Street is expecting a 20.0 percent RNOA,” the CEO continued and sent the CFO back to her office to find any “accounting tricks” to meet the target.

A. How much after-tax operating income does the CFO need to add to meet the Street’s expectations?

B. What is the likely effect of the earnings management on NOA in the current year and its implication for RNOA the following year?

C. Explain how, in general, a manipulation of current operating income has an “accounting effect,” but does not have a “valuation effect.”

Answer 1

Answer to A.

After Tax operating income is 43.7 Million which represent 19% of Net Operating Assets.

Opening net operating assets would be 43.7/19*100=230

But Expection is 20% which is 46 Million (230*20%)

Hence CFO Need to add 46 Million-43.7 Million=2.3 Million after tax operation profit in order to meet Street's expectations

Answer to B.

If Net Operating Asset will increase and rate of expection will same than profit after tax will increase, revesrely profit after tax will decrease.