Problem
Dragon Soup and Earnings Management By: Craig J Chapman
In the (A) case, Jason Phillips, Chief Financial Officer of a soup manufacturing business, is given the task of maximizing the value of the firm twelve months after the case is set. Although he does not want to break any legal rules, Jason is interested to see whether accounting and real action choices can be used to enhance the company's financial position and increase its perceived value to investors.
Using the Excel spreadsheet provided, and the recommended consequential disclosures as a basis for your analysis, what recommendations would you give Phillips on each of the items listed below?
In each case, justify your recommendation and estimate how much the decision will change the true value of the company?
The lease or buy decision, including whether to structure as an operating lease.
The regular price of soup, whether or not to run an end-of-year promotion and target end-of year inventory level.
Whether or not to ask Dunwood to guarantee the account receivable.
Whether or not to reduce the end-of -year provision for bad debts due to recent strong collection experience.
Whehter or not to sell the different investments and, if the recommendation is not ot sell the mortgage-backed securities, how to value them on the end-of-year balance sheet assuming market conditions do not change.
Given your recommendation, how much do you thing a potential buyer will offer based upon a valuation earnings multiple of ten times sustainable earnings, plus the value of cash and marketable investements onthe balance sheet.
In the case, Philips questioned how far he should push the envelope. Why should he be concerned if all the actions you recommended are legal? Do you think the associated disclosures satisfy the SEC requirements that a company provides a narrative explanation of its financial statements that enable investors to see the company through the eyes of management?