CFA Level I · CFA Level I Exam · Financial Reporting Quality
Which of the following actions is most likely an example of earnings smoothing through accrual manipulation?
Recording a larger warranty provision in a strong year and releasing part of it in a weak year is earnings smoothing. The reserve moves income from good periods into poor ones, which reduces reported volatility without any change in underlying economic performance.
- ARecording a larger warranty provision in a strong year and releasing part of it in a weak yearCorrect
- BDisclosing segment results in more detail than the standards require
- CReporting a lower effective tax rate because of a change in tax law
Explanation
Building up a provision in good years and releasing it in poor years (a 'cookie jar' reserve) shifts earnings between periods to reduce volatility. Extra segment disclosure improves transparency. A tax law change is an economic effect, not manipulation.
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