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Possible motivations for an “earnings bath”

Background Information and Reporting Task

You are a junior accountant with Factional Ltd, a large, publicly-listed company operating in the high-tech sector. Factional Ltd has recently appointed a new chief Executive Officer (CEO), Mr Magnus Bouche, who is due to take up his appointment very shortly. Last night, at the invitation of a friend, you attended a prestigious charity function which, coincidentally, was also attended by Mr Bouche. At one point during the night, you found  yourself standing quite close to (but unobserved by) Mr Bouche and overheard a part of his conversation with friends, including his comment that the first thing he intended to do as CEO of Factional Ltd was to “take a bath”.

You are not sure of what it means to “take a bath”, but the conspiratorial tone of the conversation and the fact that one of Mr Bouche’s friends responded to the comment by asking about the likely impact on Factional Ltd’s share price, while another laughed and said something (which you couldn’t quite hear) about Mr Bouche’s put options in Factional Ltd shares, have aroused your suspicions.

This morning, you spoke confidentially to your supervisor in the accounting department of Factional Ltd, Ms Betta Golightly, telling her about the overheard conversation and asking her whether she knew what it meant to “take a bath”. She replied that she had heard of the Big Bath Hypothesis and knew that it related to earnings management, but confessed that she didn’t know about any likely capital markets impacts. She then asked you to conduct some research and prepare a report for her, outlining the following:

  1. Possible motivations for an “earnings bath”
  2. How an “earnings bath” may be achieved

iii.        Whether an “earnings bath” has implications for a firm’s share price

  1. Whether an “earnings bath” has implications for the value of a firm’s stock options.

 

Your report will provide the basis for Ms Golightly’s decision on whether the matter should be brought to the attention of Factional Ltd’s audit committee (a sub-committee of Factional Ltd’s board of directors).

 

Report Requirements:

Report Format: Your report must conform to ‘Basic Report’ structure – see ‘Business Report Handout’ on Blackboard. You should keep in mind that your report is intended to be submitted to the audit committee of Factional Ltd.

Referencing:  Your report must be fully referenced in-text and also include a list of references. The ‘RMIT Business’ version of Harvard referencing is required.  For details of this referencing system go to https://www.dlsweb.rmit.edu.au/bus/public/referencing/index.html.

Word Limit:  1,000 words (not including reference list).

Weighting:  20%

Submission:  Your report must be lodged electronically via the course Blackboard site (includes automatic submission to Turnitin). Note that your report must be submitted as a Word document. Also note that there is no need for a coversheet, as this will only increase the Similarity index for your submission. Ensure you obtain a Turnitin receipt and note its number. In rare instances, problems can occur during the electronic submission process. In the event of a dispute over whether your report was lodged correctly or on time, your Turnitin receipt can provide evidence of this. Without a receipt, you have no evidence!!  (Hard copy submissions are not required.)

Marking:  You should refer to the marking rubric, on page 3 of this document, which indicates the criteria upon which your report will be marked. All reports will be marked electronically, and marks and comments made available to you electronically upon completion of the marking process.

 

Due Date:  Monday 28 September 2015 at 10:00pm (Singapore time).

Attachments:

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