Tobin Yoakam, CFA, is analyzing the financial performance of Konker Industries, a U.S. company which is publicly traded under the ticker KONK. Yoakam is particularly concerned about the quality of Konker's financial statements and its choices of accounting methodologies.Below is a summary of Konker's financial statements prepared by Yoakam.Konker has an operating lease for several of its large machining tools. The lease term expires in five years, and the annual lease payments are $2 million. The applicable interest rate on the operating lease is 9%. Yoakam believes that the operating lease should be capitalized and treated as a finance lease. For purposes of adjusting the financial statements, Yoakam believes that the machining tools should be depreciated using straight-line depreciation with a salvage value of $3 million.At the beginning of 20X8, Konker formed a qualified special purposes entity (QSPE) and sold a portion of its accounts receivables to the QSPE. The total amount of accounts receivables sold to the QSPE was $13.5 million. Yoakam has noted in his research that the Financial Accounting Standards Board (FASB) is considering the elimination of qualified special purposes entities.Konker has three major operating divisions: Konker Industrial, Konker Defense, and Konker Capital. Yoakam has computed the EBIT margin for each division over the last three years as well as the ratio of the percentage of total capital expenditures to the percentage of total assets for each division.Since Yoakam is concerned about the quality of Konker's earnings, he decides to analyze the accrual ratios using the balance sheet approach. The table below contains the last three years of accrual ratios for Konker and the industry average.Based on the balance sheet accruals ratios, Yoakam would most likely conclude which of the following regarding the earnings of Konker?
Tobin Yoakam Cf 1 (52.61 KiB) Viewed 106 times
Tobin Yoakam Cf 2 (14.5 KiB) Viewed 106 times
A. The volatile accruals ratios are indicators that Konker may be manipulating earnings.
B. Konker's earnings quality was lower than its peer group in 20X8 but higher in 20X6 and 20X7.
C. Konker's earnings quality worsened from 20X6 to 20X8 but was superior to its peer group over the 3-year period.
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