Using only the information found in Exhibit 1 and Exhibit 2, which of the following is most indicative of lower earnings quality?

High Plains’ average net operating assets at the end of 2008 and 2007 was $977.89 million and $642.83 million, respectively.

Using only the information found in Exhibit 1 and Exhibit 2, which of the following is most indicative of lower earnings quality?
A . High Plains’ discretionary expenses.
B . The change in High Plains’ depreciation method.
C . High Plains’ inventory cost flow assumption.

View Answer

Answer: A

Explanation:

Maintenance and repairs, and advertising and marketing, are discretionary expenses. Both items are declining as the investment in capital assets and sales are increasing (investment in capital assets is increasing because CFI is greater than depreciation expense for the period). The change to the straight-line depreciation method is certainly less conservative.

However, measuring earnings quality based on conservative earnings is an inferior measure. (Study Session 7, LOS 25.d,f)

Note that the reason answer C is incorrect is that using LIFO as an inventory cost flow assumption during periods of stable or rising prices would cause net earnings to reflect economic (real) earnings, thereby leading to a higher quality of earnings.