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Module 12 Homework Assignment. Kate Johnson. N umber 1: Accounting for Research and Development and Economic Profit Measures: the Importance of Forecasting until Steady-State is Reached and an Illustration of Hidden Reserves. Background.

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Number 1: Accounting for Research and Development and Economic Profit Measures: the Importance of Forecasting until Steady-State is Reached and an Illustration of Hidden Reserves


Background
Background

  • Many consultants recognize that expensing R&D investments gives a poor indication of the performance of a firm or its managers because investing in R&D results in lower income

    • Thus, they adjust GAAP accounting by capitalizing R&D expenditures and amortizing the capitalized amount over the estimated life of the revenues that flow from the expenditures




Part b capitalization
Part B: Capitalization

  • Note: After 5 years, the capitalized assets become fully amortized





Part e do the valuations differ
Part E: Do the valuations differ?

  • They shouldn’t, but mine did





Background1
Background Valuation: Earnings Management

  • Start up firm embarks on an investment program in 2013 to manufacture and market a new switching device to be used in communications

  • Program requires an initial investment of $600 million in plant and equipment, increasing by $100 million each year for four years up to 2017, and then continuing at $1,000 million thereafter


Background cont
Background, cont. Valuation: Earnings Management

  • The founders of the firm are keen to look profitable when they expect to take the firm public in an IPO in early 2018

  • After awarding him stock options, they ask the newly hired CFO to prepare forecast statements of earnings and return on investment

  • The marketing manager supplies the CFO with the following sales forecasts (in millions of dollars), and he and the production manager estimate that operational expenses before the depreciation will be 70% of sales


Part a forecasts of epat and nea
Part A: Forecasts of EPAT and NEA Valuation: Earnings Management

  • Ignoring tax effects


Part b which set of forecasts show the firm to be more profitable in 2017 prior to the ipo
PART B: WHICH SET OF FORECASTS SHOW THE FIRM TO BE MORE PROFITABLE IN 2017 (PRIOR TO THE IPO)?


Part c cfo wants to see
Part c: cfo wants to see PROFITABLE IN 2017 (PRIOR TO THE IPO)?


Part d reply
Part d: reply PROFITABLE IN 2017 (PRIOR TO THE IPO)?


Part e justifying depreciation methods
Part e: JUSTIFYING DEPRECIATION METHODS PROFITABLE IN 2017 (PRIOR TO THE IPO)?


Ethical issues
ETHICAL ISSUES PROFITABLE IN 2017 (PRIOR TO THE IPO)?

  • Accounting: We want to accurately display the value at any point in time

    • Depreciation methods make a firm look better or worse than actuality at different points

      • Is this ethical? Doesn’t this defeat the purpose of accounting?

      • Misleading investors?


Questions
Questions? PROFITABLE IN 2017 (PRIOR TO THE IPO)?


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