CFA Practice Question

CFA Practice Question

All of the following are early warning signs of probable accounting shenanigans EXCEPT ______.
A. increasingly fierce competition
B. prior management behavior of accounting manipulations
C. when a company alters its inventory valuation policy from FIFO to LIFO when input prices are expected to rise
Explanation: Switching from FIFO to LIFO during rising prices is a conservative policy to reflect profitability accurately. Under the mentioned circumstance it is not a shenanigan.

User Contributed Comments 15

User Comment
george2006 C is correct. But why A is warning sign?

because increasing fierce competition, more likely mgmt has to resort to accouting tricks. maybe.
malley Intensifying competition means tougher times for the company. It may force management to "cook the books" to maintain the appearance of continued profitability.
pjdeschenes I disagree. Switching inventory accounting methods may be conservative with respect to current earnings, but what happens if prices continue to rise, inventory drops and the company dips into a LIFO layer? Earnings increase, but these are low quality earnings.
malawyer Earnings DO NOT increase when prices are rising and LIFO method is applied as COGS are rising, no matter how high inventory is (which affects cash flow, though). In fact, earnings DECREASE as do taxes (which is why it is preferred in the first place in an inlationary / price-rising environment).
Yannicklin I guess it right even though i did not know the meaning of "shenanigan". Am I supposed to know this word?
CjjCjj wikipedia: "A shenanigan is a deceitful confidence trick, or mischief causing discomfort or annoyance"
StanleyMo what if company intends to keep more cash , by paying less tax? ...
scotty21 stanley: From the point of view of the IRS/IRD, C would definately be considered a warning signs for accounting 'shenanagins'. However this is for financial accounting not tax accounting.
TonyBalogna To Yannicklin, I would assume they would expect you to know the meaning of "shenanigan", after all the reading 41 in volume 3, Financial Reporting and Analysis is titled "Accounting Shenanigans on the cash flow statement"
Gooner7 Moving to lifo for inv. valuation purpose during rising prices is MORE AGGRESIVE (HIGHER PRICES REFLECTED IN 'VALUING INVENTORY'). It should have read "valuing COGS as LIFO"
charlie Gooner7: no. being aggressive means more profit shown in the income statement, not more inventory shown on the balance sheet.
Kashi2010 LIFO will decrease profits, but also decrease carrying value of inventory. As such assuming sales remain the same the inv turnover ratio will increase, creating the illusion of greater efficiency - this to me would be a 'shenanigan'.

It would also create a larger difference between CFO and NI, which I thought would be a warning sign also?

All to subjective... They chose to look at it from one side, I chose to look from the other side - I cant see how I am wrong based on what I chose as my concern as an analyst, yet I drop a mark..?!
mindi LIFO is more accurate recognition of COGS when prices are rising, despite the decrease in inventory value on the balance may seem like shennigans.

also, the Fraud Triangle on the notes states that there are three reasons to commit fraud: i) Opportunity; ii) Pressure, i.e. increasingly fierce competition; and iii) rationalization.

so C is correct
Friso I disagree. It doesn't rule out a shenanigan if it's a conservative policy, it's still changing the looks of the balance sheet.
Accounting tricks have happened in low competition markets as well (Enron, Worldcom) so I would consider fierce competition not a warning sign of possible accounting trickery.
SKIA I read this as "Prior Management behavior" doing something, not current management's prior behavior and automatically chose this answer as I was rushing -- read the questions!
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