What Earnings Strategy Do You Think Emerson Has Applied over the Years to Maintain Its Record of Earnings Growth?

• What earnings strategy do you think Emerson has applied over the years to maintain its record of earnings growth?

Income smoothing

• Describe the extent you believe Emerson’s earnings record reflects business activities, excellent management, and/or earnings management.

The stable increasing trend of the earning during the 20 years reveals Emerson’s key business is growing. The excellent management are making the proper decisions and enables Emerson to show increasing of earning on their financial statement. Emerson is using income smoothing as their earnings management strategy and managers decrease or increase reported income so as to reduce its volatility, and the earnings trend is increasing.

• Describe how Emerson’s earnings strategy is applied in good years and bad.

In good year， the company have higher earnings, and they will record higher expense accruals and to reduce future losses. In bad year, company will record lower expense accrual and increase current years’ net income.

• Identify years where Emerson likely built hidden reserves and the years it probably drew upon hidden reserves.

Y5 could be the year Emerson drew upon hidden reserves because the increase from Y4 to Y5 is only 2.8 million, which is much more less than increases of other years, this might be the company want to drew upon hidden reserves to keep the earnings consistently increase. Y18, Y19, Y20 might be the year Emerson built hidden reserves because their increase is way larger than other years.

Reserves for (1) bad debts and (2) inventory, along with the (3) large accruals associated with restructuring charges, are transactions that sometimes yield hidden reserves.

a. For each of these transactions, explain when and how a hidden reserve is created.

b. For each of these transactions, explain when and how a hidden reserve is drawn down to boost earnings.

a. Bad Debts: A bad debts reserve is created by overstating the amount of uncollectible accounts.  A bad debts reserve is created when the current financial results are good but the forecasted financial results are expected to be poor.  The reserve is created to decrease volatility in earnings.

Inventory: An inventory reserve is created when a company overstates their expected inventory losses.  An inventory reserve is created by debiting COGS and crediting “inventory reserve” as a contra asset account.  The reserve is created in periods before sales are supposed to decrease.

Large Accruals (restructuring charges): A restructuring charge reserve is an accrued expense to cover the costs of later closing down a portion of a business.  It is created when a company decides