Major League Products provides merchandise carrying the logos of each fan’s favorite major league team. In recent years, the company has struggled to compete against new Internet-based companies selling products at much lower prices. Andrew Ransom, in his second year out of college, was assigned to audit the financial statements of Major League Products. One of the steps in the auditing process is to examine the nature of year-end adjustments. Andrew’s investigation reveals that the company has made several year-end adjustments, including (a) a decrease in the allowance for uncollectible accounts, (b) a reversal in the previous write-down of inventory, (c) an increase in the estimated useful life used to calculate depreciation expense, and (d) a decrease in the liability reported for litigation.
1. Classify each adjustment as conservative or aggressive.
2. What, if anything, do all these adjustments have in common?
3. How do these adjustments affect the company’s cash balance?
4. Why might these year-end adjustments, taken together, raise concerns about earnings management?