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Earning Management Exercise

Earning Management Exercise. Lauren Walaszczyk. Accounting for R&D. $1.60 of revenue for each dollar spent. A) Income, RNEA, REI  GAAP Accounting. B) RNEA, REI  Capitalizing R&D. C) Why are RNEA and REI so different under each accounting treatment?.

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Earning Management Exercise

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  1. Earning Management Exercise Lauren Walaszczyk

  2. Accounting for R&D • $1.60 of revenue for each dollar spent

  3. A) Income, RNEA, REI  GAAP Accounting

  4. B) RNEA, REI  Capitalizing R&D

  5. C) Why are RNEA and REI so different under each accounting treatment? • When R&D is capitalized, NEA changes each year and EPAT is higher in the earlier years leading to a difference in the RNEA.

  6. D) Forecasted RNEA & REI for 2020

  7. D) Forecasted RNEA & REI for 2020

  8. E) Value of the firm using different accounting treatments

  9. E) Value of the firm using different accounting treatments

  10. F) If you forecasted to only 2016, what difficulties would you face? • The difficulty of valuing the firm in 2016 is the timing of the R&D expense. In the GAAP method, more R&D is being expensed than in the capitalizing method, leading to higher EPAT for the capitalizing method. Also, steady state has not been met in either accounting method.

  11. G) Decrease R&D by $20M starting in 2016 • RNEA is higher because net income is now higher due to the lower R&D expenses. This leads to a higher return on the assets.

  12. Depreciation

  13. A) EPAT & NEA – 3 year depreciation

  14. A) EPAT & NEA – 5 year depreciation

  15. B) Which set of forecasts show the firm to be more profitable in 2017? • The company appears to be profitable with the 3 year depreciation because the depreciation is expensed quicker causing net income to be higher in the later years.

  16. C) Valuation using DCF

  17. C) Valuation using DCF

  18. D) Founders insist that the market will give higher value if higher earnings are reported at time of IPO. • Although both methods give the same intrinsic value, investors do place higher value to companies with higher net income. Most investors do not realize that net income evens out in the future leading to the same value. If this were the case, the Company would want to use the 5 year depreciation.

  19. E) Profits in 2022

  20. E) Profits in 2022 • Net income over the two depreciation methods evens out leading to the same net income. Timing of the depreciation does not change the overall effect or valuation.

  21. QUESTIONS?

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