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Financial Reporting and Analysis (6th Ed.)
Chapter 7 Solutions
The Role of Financial Information in Contracting
Exercises
Exercises
E7-1. Understanding debt covenants
Debt covenants are restrictive provisions written into loan agreements by the
lender. Covenants are designed to reduce potential conflicts of interest
between the lender and borrower. Typical restrictions include limits on
additional debt, dividend payments, mergers, asset sales, as well as the
various accounting-based covenants described in the chapter. Lenders
include covenants as a form of protection against managerial actions that
might unfairly reduce the likelihood of debt repayment. Borrowers agree to
these restrictions because it reduces the cost of borrowing. Without
covenants, lenders would charge more for the loan (a higher interest rate) as
compensation for the added risks of lending. Debt covenants make both
borrowers and lenders better off.
E7-2. Tying contracts to accounting numbers
Advantages:
• Low cost: Since the borrower (company) must produce financial

statements anyway, there is no added out-of-pocket cost to using these
same statements as a basis for loan agreements.
• Accounting numbers are audited: Since the financial statements are

audited by independent accounting firms, lenders can be assured that the
reported numbers are relatively free from error and material
misstatements.
Disadvantages:
• Management manipulation: Even though the financial statements are

audited, management still has some discretion over the reported numbers
statements. Opportunistic reporting can never be completely ruled out.
Examples include voluntary accounting method changes and changes in
accounting estimates.
• Mandatory accounting changes: Accounting-based loan covenants can

be influenced by mandatory accounting changes imposed by the FASB or
other regulatory group. Lenders may feel that such changes detract from
7-1
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
the ability of accounting numbers to accurately portray changes in a
borrower’s credit risk. And, mandatory accounting changes may cause
borrowers to be in technical violation of debt covenants even though there
has been no real change in underlying default risk.
E7-3. Debt covenants and accounting methods
There are several reasons lenders may not want to require borrowers to use
specific accounting methods. One important consideration is just the cost
associated with keeping multiple sets of accounting records. Suppose a
company had five loans, each from a different bank, and each bank required
the company to prepare financial statements using a “fixed” set of accounting
methods. Five loans, five banks, and five sets of books! This could prove to
be very costly, especially if the loans required attestation by an independent
accounting firm (five audits?).
Allowing some discretion also benefits lenders because managers can then
adapt their accounting methods to the company’s changing economic
circumstances. Example: changing to LIFO inventory accounting when raw
material price increases are expected. LIFO accounting can save tax dollars,
and this cash flow improvement makes the debt less risky.
Another reason lenders may not want to require “fixed” accounting methods is
that GAAP has a built-in tendency for conservatism (i.e., to understate assets
and income, and to overstate liabilities).
Despite these reasons, some lenders do stipulate the accounting method(s)

to be used in preparing financial data for loan covenant compliance purposes.
E7-4. Sunshine Groceries Inc.: Sales-based bonus plan
There are two different ways to grow sales at Sunshine Groceries: (i) grow
sales at existing stores by increasing customer traffic and/or the amount each
customer spends per visit; and (ii) grow sales by opening new stores. The
first approach—typically referred to as “organic” growth—yields increased
earnings as long as each new sales dollar more than covers incremental
costs (e.g., the cost of the item sold plus sales commissions, etc.). The
second approach, on the other hand, will not yield increased earnings unless
the sales dollars generated from the new store exceed all of the operating
costs associated with that store (including store rental, utilities, taxes, etc.).
It makes sense for the company to award bonuses based on sales growth
because increased sales can lead to increased profits at the company.
However, this compensation policy can also lead to poor business decisions.
For example, managers may boost sales (and their bonuses) through the use
of extreme price discounts where each sales dollar falls short of covering the
7-2
Education.
cost of the item sold. Or, managers may boost sales by opening new stores
in unprofitable locations. Notice too that this sales bonus approach provides
no incentive for managers to reduce expenses.
To encourage managers to increase sales profitably, many companies pay

bonuses based on a combination of sales growth and earnings growth.
E7-5. McDonald’s Corporation: Pay disclosure lawsuit
Country club membership is likely to be one of those pay components that

shareholders find troublesome. Why? Because the business purpose of the
membership is sometimes difficult for management to explain and for
shareholders to understand. The question shareholders want answered is:
How does country club membership increase the value of the company and
thus the value of my stock?
Some companies may be reluctant to disclose pay components of this sort

because doing so could attract greater investor (and perhaps regulatory)
scrutiny of pay practices even in situations where the pay component has a
clear and compelling business purpose.
E7-6. Regulatory costs
Taxes and regulations can transfer wealth from companies and their
stockholders to other groups or individuals. Consider, for example, local
property taxes paid by a company. These taxes represent a wealth transfer
from the company (and its stockholders) to various beneficiaries—often local
school districts, their employees, students, and their parents.
Electricity rate regulation provides another example. State utility regulators

set the price of electricity so that stockholders can earn a “fair” rate of return
on their investment. If they earn too small a return, the company is allowed to
raise its prices, transferring wealth from customers to stockholders. On the
other hand, if stockholders earn too high a return, regulators force the
company to lower its prices, transferring wealth back to customers.
Regulatory costs are important for understanding a company’s financial

reporting choices because financial statement data are used by regulators to
justify taxes and to set rates charged by utility companies. Consequently,
companies have an incentive to “manage” their financial statements in ways
that will influence regulators favorably. Local companies do not want to
appear too profitable for fear that property taxes might be raised. Electric
utility companies also do not want to appear too profitable for fear that their
rates might be reduced.
7-3
Education.
E7-7. Regulatory accounting principles
When “construction in progress” costs are included in the rate base,

regulators are allowing the company and its shareholders to earn a return on
those costs before the construction project is completed. Other things equal,
this should benefit shareholders at the expense of customers (who must pay
higher rates). Here’s an example:
($ in millions) CIP included CIP excluded
Allowed operating costs $1,120 $1,120
Assets in service $3,200 $3,200

Construction in progress 500 0
Allowed assets $3,700 $3,200
Allowed return on assets (8%) $296 $256
Revenue requirement1 $1,416 $1,376

 Estimated demand (millions of KWH) 14,000 14,000
Rate allowed per KWH $0.1011 $0.0983
1Thisis the amount of revenue needed to cover all operating expenses and still earn net
income equal to the “allowed” amount.
In this case, including CIP in the rate base allows the company to set
electricity prices so that it receives $1,416 million in revenue rather than only
$1,376 million. What’s the source of the added revenue? Customers pay
10.11 cents per KWH instead of 9.83 cents per KWH. Once the project has
been completed, however, the CIP costs are transferred to “operating assets”
and the allowed revenue number then becomes the same.
Notice also that including CIP costs in the rate base may actually benefit
customers if it results in earlier construction of additional and more efficient
generating facilities, transmission systems, and distribution systems. That’s
because the new facilities and systems might well result in lower future
customer costs per KWH.
E7-8. Equipment repairs and rate regulation
The answer depends on when rates will be adjusted as well as how the
tornado loss is classified for rate-making purposes. Let’s compare two
different situations: rates set in the year of the loss versus rates set one year
later.
7-4
Education.
Rates Set in Loss Year Rates Set One Year Later
($ in millions) Expense Capitalize Expense Capitalize
Allowed operating costs (before loss) $600.00 $600.00 $600.00 $601.00
Tornado damage 5.00 – – –
$605.00 $600.00 $600.00 $601.00
Assets in service $1,600.00 $1,600.00 $1,600.00 $1,600.00

Capitalized tornado damage – 5.00 – 4.00
Allowed assets $1,600.00 $1,605.00 $1,600.00 $1,604.00
Allowed return on assets (8%) $128.00 $128.40 $128.00 $128.32
Revenue requirement1 $733.00 $728.40 $728.00 $729.32

 Estimated demand (millions of KWH) 14,000 14,000 14,000 14,000
Rate allowed per KWH $0.05236 $0.05203 $0.05200 $0.05209
1Therevenue requirement is the sum of allowed operating costs (with or without tornado
damage) and the allowed returns.
If electricity rates are set in the loss year, it is better for shareholders to have
the company treat the repairs as an expense. That’s because doing so
produces the highest allowed revenue—$733 million. But this also means that
customers pay the full cost of the tornado repairs (through higher rates) in
the first year and in each year thereafter until rates are set again.
If electricity rates are set in the loss year and the repairs are capitalized,
customers may still pay the full cost of the repairs—but over an extended
period of time. The exact amount paid and the timing depends on when rates
are set again.
If rates are to be set one year after the tornado loss (but not the loss year), it
is better for customers (but worse for shareholders) if the repairs are
expensed in the loss year. That is because the repairs will then not be
recovered in higher electricity rates—shareholders, not customers, bear the
cost of the tornado.
If the repairs are capitalized, and rates are set in the year after the loss,
customers pay for some (but not all) of the tornado damage. Notice that
allowed operating costs in the example are $601 million—the extra $1 million
represents depreciation of the capitalized repair costs (over a 5-year period).
Capitalization produces the highest allowed revenue—$729.32 million.
Notice too that if rates are set both years, it is still better for shareholders (but
worse for customers) to expense the repairs immediately because the entire
cost of the repairs is recovered the first year. As a practical matter, some
state utility commissions allow unusual losses such as this to qualify for
special rate relief.
7-5
Education.
E7-9. Maintaining capital adequacy
Requirement:
Banks and insurance companies are required to maintain minimum levels of
investor capital for two reasons. First, it provides a cushion to ensure that
funds are available to pay depositors and beneficiaries. Second, investors
who are also managers will make less risky business decisions when some of
their own money is at stake. See the discussion in E7-10.
Minimum capital requirements affect the financial statements which banks

and insurance companies prepare for shareholders in at least two ways:
• There’s expanded disclosure regarding a company’s capital structure and

its compliance with regulatory capital requirements.
• Certain “exotic” financial instruments that count as investor capital for

regulatory purposes (and are shown as capital in the financial statements)
may in fact be debt and should be so regarded by analysts. Example:
mandatorily redeemable preferred stock.
E7-10. Identifying conflicts of interest and agency costs
An agency relationship: whenever someone hires another person (the

agent) to act on his or her behalf. Jensen and Meckling (p. 308) define an
agency relationship as “a [formal or informal] contract under which one or
more individuals (principals) engage another person (the agent) to perform
some service on their behalf which involves delegating some decision-making
authority to the agent.” Agency costs are what the principals pay (in reduced
wealth or utility) when they delegate decisions to the agent. An example: the
expected value of profits lost to the BookWorm owner when the manager
closes the shop to join an old friend for lunch.
In the oil and gas drilling partnership, the general partner—Huge Gamble—
makes all the operating decisions. Huge Gamble is the agent for the investor
group (you and your friend). Is there any agency conflict here? Yes,
because Huge Gamble gets paid regardless of whether oil and gas are
discovered or not, but investors win only if petroleum deposits are uncovered.
According to the management contract, Huge Gamble is reimbursed for all
“operating costs” and receives a share of the profits if oil and gas are found.
This contract structure encourages Huge Gamble to overspend by taking
risky bets on exploration. After all, Huge Gamble has little downside risk (all
costs are reimbursed) and big upside potential if oil and gas are discovered.
This tendency to overspend is a cost of the agency relationship.
7-6
Education.
See: M.C. Jensen and W.H. Meckling, “Theory of the Firm: Managerial
Behavior, Agency Costs and Ownership Structure,” Journal of Financial
Economics (October 1976), pp. 305–360; and M.A. Wolfson “Empirical
Evidence of Incentive Problems and Their Mitigation in Oil and Gas Tax
Shelter Programs,” in Principals and Agents: The Structure of Business
(Boston, MA: Harvard Business School Press, 1985), pp. 101–125.
7-7
Education.
Chapter 7 Solutions
Problems
Problems
P7-1. Krispy Kreme’s bonus plan
Requirement 1:
Shareholders benefit when Krispy Kreme opens new doughnut shops that
earn a rate of return on invested capital (ROIC) that exceeds the company’s
cost of capital. Only then is the new doughnut shop a positive net present
value project.
The bonus plan rewards managers for increasing earnings—the numerator in

ROIC. But the bonus plan ignores the ROIC denominator—invested capital.
As a result, managers may be encouraged to open negative net present
value doughnut stores; i.e., stores that earn a profit but not an ROIC greater
than the cost of capital.
Requirement 2:
Using the same profit performance definition (EBITDA) in the company’s loan
covenants as the profit performance definition in the bonus plan helps ensure
that managers pay incentives are aligned with the company’s debt covenant
compliance incentives. This approach reduces potential incentive conflicts;
i.e., situations where managers take actions that increase the pay metric but
simultaneously decrease the covenant metric.
Requirement 3:
A variety of accounting gimmicks can be used to enhance managers’
bonuses when those bonuses are based on accrual earnings (EBITDA) or
accounting revenues. These include changes in accounting methods,
changes in accounting estimates, and other accrual manipulations discussed
throughout the book. These abuses also include real transaction possibilities
such as forcing franchisees to buy doughnut mix and supplies before they are
really needed (channel stuffing).
7-8
Education.
P7-2. Krispy Kreme’s compensation recovery plan
Requirement 1:
Annual and long-term compensation plans can contribute to agency problems
by encouraging managers to take actions that enhance their pay (and thus
personal wealth) to the detriment of shareholders. These actions may involve
real transactions such as opening new stores in unprofitable locations or
channel stuffing (see P7-1). The actions may also involve financial
accounting decisions such as premature revenue recognition or delayed
expense recognition. Krispy Kreme’s compensation recovery plan, which is
similar to the recovery plans adopted recently by a number of U.S.
companies, is focused on actions detrimental to shareholders that later
trigger an accounting restatement.
Requirement 2:
Here are two examples:
• Overstating revenue for the quarter by forcing retail franchises to

purchase doughnut mix and supplies before the items are actually
needed (channel stuffing).
• Understating expenses for the quarter by recording certain operating

costs as part of new store acquisition costs.
Both examples are taken from the company’s description of the accounting
abuses that led to its restatement.
Requirement 3:
The pay recovery plan is aimed at reducing managers’ incentives to inflate
reported financial statement results and thus their annual and/or long-term
compensation awards. This formal requirement to repay “ill-gotten gains”
should discourage accounting abuses.
P7-3. Medical malprofits
When doctors own the hospitals where they work, they may be tempted to
overprescribe or overdiagnose medical treatments and procedures. That’s
because hospital profits flow to the doctors who make decisions about the
scope and level of treatment and diagnosis. Third-party reimbursement and
trusting patients may not be effective impediments to this behavior.
7-9
Education.
P7-4. Foot Locker, Inc.: Anticipating covenant violation
Requirement 1:
A minimum fixed charge coverage ratio covenant limits the company’s ability
to pay dividends or make capital expenditures by requiring that fixed
charges—current maturities on debt, dividends, and capital expenditures—
not exceed a specified multiple of net income, adjusted net income, or
operating cash flow. Using the example from the chapter for instance, we
find that a minimum fixed-charge coverage ratio of 1.0 limits dividend to no
more than $15. The purpose served by this covenant is to restrict the
company’s ability to spend cash in ways that may be disadvantageous to the
lender.
Requirement 2:
By agreeing to this restriction, Foot Locker promises to keep more cash in the
company for possible use in paying down its loans. This reduces Foot
Locker’s credit risk when viewed from the perspective of the lender, and thus
should reduce the company’s cost of obtaining borrowed capital.
Requirement 3:
Consider the minimum fixed charge coverage ratio mentioned in Requirement
1 and described in the chapter. Suppose the ratio numerator is defined by
the loan agreement to be net income plus depreciation and amortization.
Management has an incentive to make the numerator as large as possible
because this creates slack in the covenant and permits greater cash dividend
distributions and capital expenditures. Accounting gimmicks that increase net
income (e.g., LIFO inventory liquidation, understating bad debt expense,
aggressive revenue recognition) also increase the ratio numerator and
reduce the likelihood of covenant violation.
Requirement 4:
Lenders have a several options available to them when a loan covenant is
violated by the borrower. These options range from agreeing to waive the
violation, amending the terms of the loan agreement, or requiring the debt to
be paid immediately. Requiring immediate payment is the action of last resort
and often precipitates bankruptcy by the borrower.
P7-5. Frisby Technologies: Violating a covenant
Requirement 1:
A minimum tangible net worth covenant requires the company to maintain a
balance of, in Frisby’s case, at least $1.250 million of contractually defined
“tangible net worth”—stockholders’ equity minus the book value of any
intangible assets. There are two related purposes served by this covenant.
First, it provides a contractual incentive for management to profitably operate
7-10
Education.
the company because stockholders’ equity is increased by any profits earned.
Second, it restricts managements’ ability to pay cash dividends or buy back
stock because both of these actions reduce stockholders’ equity. Of course,
the more profitable the company and the less cash spent on dividends and
stock buy backs, the more cash that is available to pay down debt. Thus, the
ultimate purpose served by the covenant is to reduce the lender’s exposure
to credit risk.
Requirement 2:
Lenders are reluctant to simply waive a covenant violation when the
circumstances of the violation indicate a true deterioration in borrower credit
worthiness. If credit risk has increased, lenders will instead take advantage
of the violation to favorably alter the loan terms or demand immediate
repayment of the loan. That seems to be what is happening at Frisby.
Requirement 3:
Lenders often prefer to avoid foreclosure because the cash proceeds
obtained from liquidating a company are often quite small in comparison to
loan amounts. Lenders often structure a “work out” that allows the company
to remain in business—thereby generating future cash to payback the loan—
but with greater restrictions on the use of cash and additional personal loan
guarantees by company owners
P7-6. Tying bonus to EPS performance
Requirement 1:
According to the bonus formula, Mr. Brincat would receive a bonus of
$500,000 if the company reports net after-tax earnings of $50 million and the
EPS increase is 10 percent.
Basic bonus: 1% of $50 million = $500,000

Additional bonus: zero
Requirement 2:
According to the bonus formula, Mr. Brincat would receive a bonus of
$846,140 if the company reports net after-tax earnings of $50 million and the
EPS increase is 30 percent.
Basic bonus: 1% of $50 million = $500,000

Additional bonus: 3% of $11.538 million = $346,140
Assuming the company has not issued or repurchased stock during the
year, a 30% increase in EPS must also mean that net after-tax earnings
increased 30%. In other words $50 million = (1 + .30) x earnings last year.
7-11
Education.
So, earnings last year must equal $50 / (1.30) or $38.462 million.
The increase in net after-tax earnings would then be $11.538 million
($50.000 million - $38.462 million).
Requirement 3:
Most shareholders would not feel very comfortable if managers had this type
of compensation package. Consider, for example, the incentive bonus. It is
based on annual increases in EPS, and the larger the EPS increase, the
larger the bonus payment. But there are ways of increasing EPS that do not
increase the value of the company’s common shares. LIFO liquidations and
stock buybacks are just two examples. Notice also that Mr. Bincat’s stock
options vest only if EPS grows by 20% or more in each of the next five years.
The combination of annual bonuses and stock options tied to EPS growth
sends a clear signal to management: EPS is all that matters. Shareholders,
on the other hand, want to make certain that EPS growth translates into
higher dividends or greater share price appreciation.
P7-7. Earnings quality and pay
Requirement 1:
The first thing to note about the suggested adjustments is that there is no
mention of the nonoperating income items and gains. The list provided by
company managers is one-sided: It identifies nonoperating items that
decreased reported earnings for the year, but it does not point to any items
that increased earnings. Of course, without access to the complete financial
statements, the compensation committee would not be aware of this
intentional oversight.
Consider the three income-reducing special items:
a) Loss on early retirement of debt

b) Restructuring and other nonrecurring charges
c) Loss from discontinued operations prior to sale (net of tax)
The compensation committee could agree that the bonus should be paid
solely on the basis of reported net income and that no adjustment is
necessary. One justification for this view is that income-reducing items such
as these are offset by income-increasing items not contained on the
adjustment list.
On the other hand, a reasonable argument can be made for excluding (a)
from the bonus calculation. Here, changes in the company’s optimal financial
structure (best mix of debt and equity) may have prompted the early debt
retirement. Don’t penalize managers for making good business decisions.
7-12
Education.
A similar argument can be made to exclude (b) and (c) from the bonus
calculation. Changes in the company’s economic environment may have
contributed to the need for a restructuring and the discontinued operations.
Managers should not be penalized for making good business decisions. And,
if annual bonuses are influenced by such nonrecurring items, managers will
be less inclined to make these tough decisions in the future.
Requirement 2:
Three possibilities for the appropriate net income figure come to mind:
(a) Income from continuing operations. The rationale here is to exclude

items that have no direct bearing on the company’s sustainable income for
the year.
(b) Income from continuing operations, adjusted for all nonrecurring

items. The idea to exclude nonrecurring losses so that managers have an
incentive to restructure operations when needed, and without harming their
annual bonus. Nonrecurring gains are excluded so that managers are not
rewarded for temporary income increases.
(c) Income from continuing operations, adjusted for nonrecurring

losses only. As in (b), the rationale here is to provide managers with an
incentive to restructure operations when needed and to reward them for any
realized gains (even those gains that are not sustainable).
For most companies, the best choice is (b).
P7-8. Avoiding debt covenant violations
Requirement 1:
For most companies, the fixed charges ratio is just a variation of the interest
coverage ratio. With only two weeks until the books are closed, the company
needs to “find some income” that can increase the numerator of this ratio.
Possible sources of income are:
• Accelerate the recognition of revenue from the first few days of next year
into the last few days of this year (i.e., leave the books open past the fiscal
year end).
• Delay the recognition of expenses from the last few days of this year until
the first few days of next year (i.e., close the books early for expenses).
• Postpone discretionary expenses like maintenance, research and
development, or advertising.
• Sell assets that have market values substantially in excess of their book
values.
7-13
Education.
• Change one or more accounting methods to increase reported earnings.
For instance: expand straight-line depreciation to all long-lived assets,
eliminate LIFO accounting.
• Change one or more accounting estimates. For instance, increase the
estimated useful lives of long-term assets, decrease salvage value
estimates or bad debt allowances.
Requirements 2 and 3:
Some actions that could be taken to avoid violating the tangible net worth
ratio are:
• Any of the actions outlined in (1) also apply here.
• Issue common stock before the end of the year.
• Reissue treasury stock before the end of the year.
• To reduce the ratio of consolidated debt to total capitalization (i.e., to total

assets), the company could retire some debt before the end of the year. If
the debt could be retired for a price close to its carrying amount, net worth
would not change much.
• The last three items could be combined into a stock-for-debt exchange

offer, although most transactions of this sort require more than two weeks’
time.
Requirement 4:
Answers to this question will vary from student to student. The dilemma
confronting the banker involves a trade-off between (a) using covenants to
restrict management’s action and thereby reduce credit risk and (b) inhibiting
management from taking prudent actions that enhance cash flows and the
likelihood of debt repayment. Students should be encouraged to see both
sides of this situation.
P7-9. Accounting in regulated industries
Requirement 1:
Duke Energy is altering readers of its published GAAP financial statements
that certain reported asset and liability items are unique to the rate-making
process, and thus do not appear in the GAAP financial statement s of non-
regulated businesses. Readers should therefore not be surprised when they
come across potentially unfamiliar asset and liability items such as the
Allowance for Funds Used During Construction.
7-14
Education.
Requirement 2:
In this particular instance, Duke Energy is reminding readers that some debt
interest costs are assigned to the balance sheet, and thus are not included in
Interest expense. Readers who overlook this reminder may mistakenly
conclude that debt interest costs (as shown on the income statement) are
lower than the company’s true cost of debt borrowing (interest expense plus
capitalized interest costs for the period).
Duke Energy is also reminding readers that certain (implicit) equity costs are
also assigned to the balance sheet as part of AFDUC even though GAAP for
non-regulated companies does not permit the capitalization of equity costs.
This accounting practice is unique to rate-regulated utility companies and
arises from the rate regulation process.
Requirement 3:
The chapter provides several examples of regulatory expense shifting where
firms have incentives to classify a cost (e.g., corporate advertising) as an
allowed operating cost rather than a cost not allowed for rate determination.
Other examples include GAAP postponement of storm damage costs if
management believes that those costs will be recovered through allowed
future rate increases. Management also has an incentive to artificially inflate
the reported asset base because utility rates (and thus revenues) are tied to
an approved accounting rate of return earned on the asset base.
P7-10. Understanding rate regulation and accounting choices
Requirement 1:
The following table shows the impact of the proposed accounting changes on
2014’s revenue requirement and rate per kilowatt hour:
7-15
Education.
Proposed accounting changes
Base Extend Increase Amortize Write-Up
($ in millions) Case Plant Life Bad Debts Takeover Costs Inventories
Allowed operating costs $1,120.0 $1,120.0 $1,120.0 $1,120.0 $1,120.0
Accounting change adjustment – (5.0) 7.0 1.5 –
$1,120.0 $1,115.0 $1,127.0 $1,121.5 $1,120.0
Assets in service $3,200.0 $3,200.0 $3,200.0 $3,200.0 $3,200.0

Accounting change adjustment – 175.0 (7.0) 3.0 60.0
$3,200.0 $3,375.0 $3,193.0 $3,203.0 $3,260.0
Allowed return at 8.75% $280.0 $295.3 $279.4 $208.3 $285.3
Revenue requirement $ 1,400.0 $ 1,410.3 $ 1,406.4 $ 1,401.8 $ 1,405.3

 Estimated demand (millions of KWH) 14,000 14,000 14,000 14,000 14,000
Rate per KWH allowed $0.10000 $0.10074 $0.10046 $0.10013 $0.10038
Alternate solution format:

Rate per
Estimated KWH
($ in millions) Demand Allowed
Current allowed operating costs $1,120.0 14,000 $0.08000
Effects of proposed accounting changes:
Extend plant depreciation life ($5.0) 14,000 ($0.00036)
Increase bad debts $7.0 14,000 $0.00050
Amortize hostile takeover costs $1.5 14,000 $0.00011
Write-up fuel and materials inventories $0.0 14,000 $0.00000
Subtotal $1,123.5 14,000 $0.08025
Current assets in service x 8.75% $280.00 14,000 $0.02000

Effects of proposed accounting charges:
Extend plant depreciation life ($175 million x 8.75%) $15.31 14,000 $0.00109
Increase bad debts ($7 million decrease x 8.75%) ($0.61) 14,000 ($0.00004)
Amortize hostile takeover costs ($3 million x 8.75%) $0.26 14,000 $0.00002
Write-up fuel and materials inventories
($60 million x 8.75%) $5.25 14,000 $0.00038
Subtotal $300.2 14,000 $0.02145
Requirement 2:
The bad debt increase seems quite plausible as long as the revised
estimate (1.5% of sales) conforms to the company’s actual experience. This
change would probably be allowed.
The inventory write-up to current replacement value makes good economic
sense. Investors should be allowed to earn a fair return (8.75%) on their
current investment in the company, not on an outdated historical measure of
that investment. If LIFO inventory accounting were used, for example, the
inventory cost numbers could be several decades old. Unfortunately,
7-16
Education.
regulators have so far rejected this line of argument and required utilities to
maintain their balance sheet at historical cost.
The plant life extension would be allowed, but not the $175 million increase
in asset book value. Instead, the company would be required to just extend
existing depreciable cost over the longer depreciation life.
Regulators would disallow amortization of the hostile takeover cost
incurred last year. This is nothing more than a bold attempt to get one of last
year’s expenditures into this year’s rate base. The company may initiate a
request for a special rate surcharge to cover this unusual expenditure, but
that too is likely to be rejected because the outlay was of little benefit to
customers.
P7-11. Determining whether citizens should have a say in CEO pay
Requirement 1:
U.S. companies are not required to obtain shareholder approval of the
compensation packages paid to top executives. Proposed pay packages are
assembled by the company’s compensation committee which is comprised of
outside (non-officer) members of the Board of Directors. These outside
directors are presumed to formulate pay packages consistent with the
interests of shareholders.
Shareholders can, and some do, put forth proposals aimed at curbing
“abusive” compensation practices such as golden parachutes, and overly
generous executive pay levels. Management can, under certain
circumstances, refuse to place the proposal on the annual meeting agenda,
and management is not obligated to implement proposed changes in pay
practices even if the garner a majority vote of shareholders.
During the 2008 proxy season, shareholders filed resolutions seeking
nonbinding (advisory) votes on pay practices at nearly 100 U.S. companies.
AFLAC Inc,, known for the quacking duck that appears in its TV commercials,
is the first public U.S. company to give investors an advisory vote on top
officers compensation. See: J. Lublin, “Say on the Boss’s Pay,” Wall Street
Journal (March 7, 2008).
Requirement 2:
One argument favoring continued use of golden parachutes is that they help
shareholders by reducing incumbent management’s tendency to fight hostile
takeover attempts. Takeovers can benefit shareholders in several ways.
First, takeover premiums are often 20% or more above the prevailing stock
price and these premiums are captured by shareholders of the target firm.
Second, takeovers are a mechanism for achieving changes in the company’s
leadership team particularly when top executives are well entrenched and
report to a “friendly” board of directors. Golden parachutes provide a type of
severance package that presumably reduces executive resistance to
7-17
Education.
takeover offers. Of course, golden parachutes also may just be one more
way of delivering overly generous compensation to top executives, and that
seems to be the view held by Mr. Minder.
Requirement 3:
It would seem that in companies with approximately $500 million in world-
wide annual sales, CEO pay in the U.S. is about 78 times the typical U.S.
worker ($2.2 million / $11.6 million x 411 = 78 rounded). A similar pay
multiple applies to European countries.
Among the reasons for supporting shareholders’ right to approve CEO pay
packages are: (1) achieve greater pay equity with workers; (2) hold CEO
more accountable for company performance; (3) ensure that CEO pay is
reduced when employees are dismissed in a company downsizing; (4) block
the actions of an overly generous compensation committee and board; and
(5) allow shareholders to determine whether executive pay practices are
effective.
Among the reasons for not supporting the right of shareholders to approve
CEO pay packages are: (1) labor market forces dictate top executive pay
levels and subjecting pay packages to shareholder approval would introduce
disruptive political forces into the pay process; (2) the costs of shareholder
approval far outweigh any economic benefits to be gained; (3) shareholders
already “vote” on corporate pay practices because the chose each day which
stocks to own and which to not own; (4) the average stockholder lacks the
skills, knowledge, or experience to properly evaluate top executive pay
practices in a modern corporation; and (5) corporate compensation
committees and the board of directors are effective mechanisms for ensuring
that executive pay practices are aligned with shareholder interests.
Requirement 4:
The distinction to consider here is the difference between allowing
shareholders the right to approve CEO pay (see Requirement 3) and allowing
non-shareholder citizens the same right. Notice that shareholders have a
direct, economic interest in the outcome but non-shareholder citizens do not
have that same economic interest. Arguments for or against a national vote
could be built around the points raised in Requirement 3. In addition, you
might consider whether national votes should be held on other corporate
matters such as election of directors, approval of corporate acquisitions and
investment decisions, or approval of dividends. Given citizens the right to
vote on such matters would dilute the rights of stockholders and make owning
shares in the company less worthwhile. This would increase the company’s
cost of obtaining external financial resources through debt or equity markets.
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Education.
Chapter 7 Solutions
Cases
Cases
C7-1. Microsoft’s “unearned revenue” account
Requirement 1:
Microsoft cannot recognize all of the revenue from software sales until it is
fully “earned.” Microsoft sets aside some software sales revenue as
“unearned” because, at the time of sale, the company still has an obligation to
provide the customer with substantial services (upgrades, support, and bug
fixes) in the future. By postponing the recognition of this “unearned” revenue
until later when the services are performed, Microsoft is just following GAAP
revenue recognition principles.
Requirement 2:
Determining how much software sales revenue to set aside as unearned
each quarter is a challenge because it requires an estimate of the future cost
of providing the promised services to customers. Developing reliable cost
estimates is no easy matter, particularly in an industry where technologies
change rapidly and software released early is often error prone.
Once a cost estimate is determined, there are two ways Microsoft could then
determine how much revenue to set aside as unearned. One approach would
set aside just enough revenue to cover the estimated future costs of
promised services. For example, suppose Microsoft expects to incur $5 in
future expenses for each $100 software package it sells. The company would
then recognize $95 of software sales revenue immediately and include this in
current earnings. The remaining $5 would be recorded as unearned revenue,
to be “earned” when the future services are performed.
A second approach would set aside enough revenue to not only cover the
estimated future costs of the promised services, but to also earn a “normal”
gross profit in the period when the services are performed. For example,
suppose Microsoft again expects to incur $5 in future expenses for each $100
software package it sells and that it’s “normal” gross profit on software sales
is 50%. In this case, the company would set aside $10 (the $5 of expected
future cost plus a $5 gross profit) of software sales as unearned.
7-19
Education.
Requirement 3:
When the “unearned revenue” account is reduced by $100 million the dollars
go to the “revenue” account and are included in net income. That’s because
they are then considered earned revenue.
Requirement 4:
Contracting incentives (compensation and debt covenants) can exert a large
influence on management’s decisions about the unearned revenue account.
Consider a situation where management bonuses are based on achieving
predetermined earnings (or earnings per share) targets. If management
believes the company will exceed its profit goal this year, they have an
incentive to increase the amount of software sales revenue set aside as
unearned. Doing so will not jeopardize the bonus payment this year and it
creates a cushion than can be used next year if the company appears to be
falling short of its profit goal. Debt covenants can also provide incentives to
“manage” the unearned revenue account, although they are unimportant for
Microsoft because the company has very little debt outstanding.
The most important regulatory incentive facing Microsoft is potential political

costs stemming from the company’s tremendous success. By increasing the
amount of software sales revenue that it classifies as “unearned”, Microsoft
can look less profitable. This may reduce the company’s political exposure to
antitrust litigation or other forms or regulatory intervention.
Requirement 5:
Analysts and investors focus on changes in Microsoft’s unearned revenue
account for several reasons. First, the unearned revenue account is a lead
indicator of future profitability since today’s “unearned” revenues become
tomorrow’s “earned” revenues. Less obvious, but undoubtedly more
important, is the fact that changes in the unearned revenue account also is
an indicator of the quality of Microsoft’s earnings. Analysts and investors look
at this account to determine if Microsoft is “managing” its earnings each
quarter—stockpiling unearned revenue in good quarters and drawing down
the account in bad quarters.
C7-2. Maxcor Manufacturing: Compensation and earnings quality
Requirement:
There are several reasons why Ms. Magee should feel uneasy about
Maxcor’s computation of 2014 operating profits:
• Some research and development (R&D) expenses are shown above the
operating profit line (in cost of goods sold) and some are below the line (as
research and development expense). The classification decision may allow
considerable discretion. For example, about 72% of total research and
engineering expense was charged to cost of goods sold in 2013 when
operating profits were still
7-20
Education.
Another random document with
no related content on Scribd:
subjoin in this, and other subsequent notes, the various alterations
made by this judicious editor, together with the original passages: the
lines he has introduced are beautifully written, and a close imitation
of the style of Terence: I cannot doubt but they will be considered
worthy of a perusal: they are a proof of a laudable delicacy, which
was but too rarely to be met with in many of the poets of both
England and France, in the 17th century.
The original passage runs thus:—
“Primùm hæc pudicè vitam, parcè, ac duriter

Agebat, lana ac tela victum quæritans:
Sed postquam amans accessit, pretium pollicens,
Unus, et item alter, ita ut ingenium est omnium
Hominum ab labore proclive ad libidinem:
Accepit conditionem, dein quæstum occipit.”
Which is altered by the French translator to the following:—
“Primum hæc pudicè vitam, parce, ac duriter

Agebat, lana ac tela victum quæeritans:
Sed postquam ad illam accessit adolescentulus,
Unus, et item alter; ita ut ingenium est omnium
Hominum ab labore proclive ad desidiam;
Sperans se cuipiam illorum uxorem fore,
Famæ haud pepercit, illosque in domum suam
Lubens admisit nimium familiariter.
“At first she lived chastely, and penuriously, and laboured hard,
managing with difficulty to gain a livelihood with the distaff and the
loom: but soon after several lovers made their addresses to her, and
as we are all naturally prone to idleness, and averse to labour, and
as they made her promises of marriage, she was too negligent of her
reputation, and admitted their visits oftener than was prudent.”
NOTE 73.
Aha! thought I, he is caught.

In the Latin, Certè captus est. Habet. Terence borrowed this
expression (habet) from the amphitheatre at Rome, where men
called gladiators, who were (for the chief part) captives and slaves,
fought before the people: who looked with great delight on these
combats, which often terminated in death to half the persons
engaged. When a gladiator was wounded, the people exclaimed
Habet, he has it, and thus the word was often used at Rome, in the
sense adopted by Terence.
NOTE 74.
He paid his share, and supped with the rest.

In the Latin symbolum dedit, he gave his ring as a token, or
pledge. This phrase is an allusion to a custom which prevailed chiefly
at Rome. When a party agreed to dine together at their own
expense, or, in other words, to club together for an entertainment:
each of the party gave his ring to him who had the care of providing
the feast, as a symbol or token that he, the owner of the ring, was to
join the company, and defray his share of the expense. Hence, he
who paid nothing, was called asymbolus. Rings were also given in
contracts instead of a bond: and used for tokens of various kinds.
The Greeks also seem to have called rings by the same name,
σύμβολα.
NOTE 75.
To give his daughter to Pamphilus with a large dowry.

The word dowry, which is called, in Greek, προὶξ, or μείλια, or
ἕδνα, originally meant the sum which a man gave to the family of the
woman he married, and with which he might be said to purchase his
wife: but, as the Greeks grew more refined, and also more wealthy,
this custom was wholly abolished; and the dowry was given by the
wife’s relations to the husband, to assist him in the maintenance of
her and of her children. The dowries of women were, in Athens,
considered a subject of great importance; and many laws were
framed by the Athenian legislators, (particularly by Solon,) to provide
for the well ordering of women’s fortunes. An heiress could be
disposed of in marriage, only by her father, grandfather, or brother: if
she had neither of these relations, the archons determined who was
to be her husband; and it was held so important to keep her estate in
the family, that at one time a law prevailed, that if an heiress had no
children by her first husband, she was taken from him by the
authority of the archons, and given to her nearest relation. A wife,
who brought a fortune to her husband, was called γυνὴ; she who
brought none παλλακὴ. Solon, apprehensive of mercenary unions, at
one time, passed a law, that a woman should carry to her husband
only some furniture, and four or five changes of dress. But this
seems to have been little observed.
The large dowry which Simo says Chremes offered with
Philumena, we may fairly suppose to have been twenty talents, as
Chremes imagined he had but one daughter to portion off; when he
had discovered Glycera, he gave her a dowry of ten talents; and we
must suppose that he reserved as much more for Philumena. This
will give us an idea of what the portions of the Athenian women
usually were, and of the fortune of a citizen.
Twenty Greek talents were nearly equal to 5,000l. sterling,
according to some authors, though writers differ widely as to the
amount of the Attic talent; Dr. Arbuthnot makes it equal to 193l. 15s.,
Mr. Raper to 232l. 3s. It is agreed on all sides that the Attic talent
consisted of 6,000 drachmæ; but the value of the drachma was
never correctly ascertained. Vide the table of monies in Note 208.
NOTE 76.
I contracted my son.
The Athenian youth were not allowed to dispose of themselves in
marriage without consulting their parents, who had almost unlimited
authority over them: if they had no parents, guardians, called
ἐπίτροποι, were appointed to control them.
But it does not appear that any particular ceremonies were used
in Athens, in contracting a bride and bridegroom, previous to the day
of marriage; and I rather imagine, Terence, in order to make the
subject clear to his Roman auditors, alluded, by the word despondi,
to the Roman custom of betrothing, called sponsalia, which they
performed as follows:—
Some days before the wedding, the intended bride and
bridegroom, with their friends, met together at the lady’s residence,
and the parent or guardian of each (as I imagine) asked each other,
Spondes? Do you betroth her or him? Then the other party
answered, Spondeo, I do betroth, &c. Then the deeds were signed,
the dowry agreed on, and the day appointed for the marriage.
NOTE 77.
Among the women who were there I saw one young girl.
Women were frequently hired on these occasions, to appear in
the funeral procession as mourners, of whom Horace says,
“Ut quæ conductæ plorant in funere, dicunt

Et faciunt propè plura dolentibus ex animoque.”
Like those, who, hired to weep at funerals,

Exceed, in noisy grief, a faithful friend.
NOTE 78.
She appeared more afflicted than the others who were there, and so
pre-eminently beautiful, and of so noble a carriage, I approach.
To understand the full force of Simo’s remark, when he says how
much he was struck with the contrast between Glycera and the rest
of the mourners, it is necessary that the reader should be informed,
that, in Athens, no woman under sixty years of age was allowed to
appear at a funeral; except the relations of the deceased. Solon
imposed this law upon the Athenians.
NOTE 79.
I approach the women who were following the body.

Literally, the women who were walking after the body. Though
those women who were hired to follow a corpse, walked in
procession, it was very usual in Greece, to attend funerals in
carriages, and on horseback: but Chrysis, not being represented as a
citizen, the ceremonies, in respect to the procession, must be
supposed to be different. The interment of the dead was considered
of such extreme importance throughout the whole of Greece, that to
want the rites of sepulture, was deemed by the natives of that
country, a much greater misfortune than even death itself. The
Greeks (and many other nations) believed that the spirit of a person
whose corpse was unburied, could never obtain admittance to the
Elysian fields: their imaginary place of reward for virtuous men after
death. Two different methods of disposing of the dead prevailed in
Greece. The most ancient of the two (as is generally allowed,) was
much the same as the modern practice, the corpse was interred in a
coffin, and deposited in the earth. The other mode was to burn the
body, and to preserve the ashes. The Athenians seem to have used
both methods indiscriminately: their funerals were usually conducted
by torch-light. On the third or fourth day after death, (though the time
was varied according to circumstances,) the corpse was placed on a
bier, with the feet towards the door; and an obolus put into its mouth,
to defray the passage across the Styx: a certain form of words was
then pronounced over the body, which was afterwards carried out,
and followed by the mourners: those of the same sex as the
deceased were to be nearest the corpse: when it was placed on the
pile, and a second form of words recited over it, some one of the
mourners, (usually the nearest relation,) applied a torch to the wood;
and, if the deceased was of high rank, animals of various kinds, and
sometimes even human victims, were slaughtered, and thrown into
the flames. The ashes of the dead were collected from the
extinguished pile into an urn, and with some further ceremonies
deposited in a sepulchre. The Romans burned their dead in a similar
manner. For a further mention of Greek funerals, vide Notes 77, 78,
80, 81.
NOTE 80.
We follow, and arrive at the tomb.

Tombs, called by the Greeks τάφοι, or τύμβοι, which signify both
the grave and the monument, were not allowed to be within the city
of Athens, but were placed either in the public burial-place, or in
private grounds belonging to the relatives of the deceased: it was not
unusual to erect them by the road side at some distance from the
city, whence the expression, so common on monuments, Siste
Viator, Stay Traveller. The public burial-place of the Athenians was in
that part of the Ceramicus situated beyond the city: it was very
extensive. The other part of the Ceramicus contained the old forum,
called ἀρχαία ἀγορὰ.
NOTE 81.
The corpse is placed on the pile, and quickly enveloped in flames;
they weep; while the sister I was speaking of, rushed forward, in
an agony of grief, toward the fire; and her imprudence exposed her
to great danger.
An eminent English poet, Sir Richard Steele, has endeavoured to
adapt Terence’s Andrian to the taste of an English audience, and has
succeeded in that attempt, in his play, called The Conscious Lovers,
as well as circumstances would permit. A French poet of equal
eminence, Monsieur Baron, has made a similar attempt in French
verse, and has met with equal success in his Andrienne: he has kept
much closer to the original than has Sir Richard Steele; indeed,
many scenes of the Andrienne are a literal version of Terence. I
purpose to point out the most material changes which the two
modern poets have made in the incidents: the bent of the dramatic
taste of the nation of each, may be discovered, in some measure,
from a comparison between the English, the French, and the Roman
dramatist. M. Baron has not made any alteration in the scene at
Chrysis’ funeral, where Simo discovers his son’s attachment to
Glycera; but Sir R. Steele, has altered the mode of discovery to a
quarrel at a masquerade; and his scene, though it may want the
pathos of the original, yet displays the filial affection of Bevil, the
English Pamphilus, in a very amiable light. Sir Richard has
modernized the characters of Simo and Sosia in Sir John Bevil and
Humphrey.
“Sir J. You know I was, last Thursday, at the masquerade:
my son, you may remember, soon found us out. He knew his
grandfather’s habit, which I then wore, and though it was in
the mode of the last age, yet the maskers followed us, as if we
had been the most monstrous figures in the whole assembly.
“Humph. I remember a young man of quality, in the habit of
a clown, was particularly troublesome.
“Sir J. Right: he was too much what he seemed to be: he
followed us, till the gentleman, who led the lady in the Indian
mantle, presented that gay creature to the rustic, and bid him
(like Cymon in the fable) grow polite, by falling in love, and let
that worthy gentleman alone, meaning me. The clown was not
reformed, but rudely offered to force off my mask; with that the
gentleman, throwing off his own, appeared to be my son; and,
in his concern for me, tore off that of the nobleman. At this,
they seized each other, the company called the guards, and,
in the surprise, the lady swooned away; upon which my son
quitted his adversary, and had now no care but of the lady;
when, raising her in his arms, ‘Art thou gone,’ cried he, ‘for
ever?—Forbid it, Heaven!’—She revives at his known voice,
and, with the most familiar, though modest gesture, hangs in
safety over his shoulders weeping; but wept as in the arms of
one before whom she could give herself a loose, were she not
under observation. While she hides her face in his neck, he
carefully conveys her from the company.”—Conscious
Lovers.
Sir John Bevil makes the same trial of his son, as Simo of his: and
young Bevil makes the same reply with Pamphilus. The only
difference in the conduct of the plot in that part is, that Bevil is not
apprized of his father’s stratagem by his own servant; but by
Humphrey, which, as it shews a sort of half-treachery in him, is an
inferior arrangement to that of the Latin poet.
NOTE 82.
That Pamphilus had actually married this strange woman.

The expression ξένα, peregrina, or strange woman, was generally
used amongst eastern nations, to signify a woman of light character:
it is very frequently employed in the Holy Writings in that sense. Vide
Judges, chap. xi. ver. 2; Proverbs, chap. v. ver. 3. 10, 20. Thais, in
the Eunuch, speaking of her mother, says,
“Samia mihi mater fuit: ea habitabat Rhodi.”
My mother was born in Samos, and dwelt in Rhodes.
Athenian citizens were not allowed to marry foreign women, even

of reputation and virtue; this law was not strictly observed: the
penalty for the violation of it was fixed at one thousand drachms.
Simo mentions the epithet peregrina, as what Chremes said he had
heard Glycera called; but does not himself drop the slightest hint
against her, but, on the contrary, praises her modest demeanour; as
he must have been well aware, that she did not deserve such an
epithet, being her opposite neighbour, and having seen her abroad:
ξέναι, or strange women, when they appeared in public, were obliged
to wear striped dresses, to distinguish them from women of innocent
conversation.
NOTE 83.
Of a wicked mind, one can expect nothing but wicked intentions.

In the Latin, mala mens, malus animus. It is not easy to
discriminate with accuracy the different meanings the Romans
attached to mens and animus. Some think that animus meant the
heart, and mens the faculty of thinking. Grotius has, in this passage,
taken those words to signify conscience and judgment: but, I think it
probable, that the word animus was usually employed when they
spoke of the soul, and that mens was intended to express what we
understand by the word mind, when we speak of greatness of mind,
or littleness of mind. Animus was, perhaps, about equivalent to that
elegant expression,—instinctus divinitatis.
NOTE 84.
Exit Sosia.
“Here we take our last leave of Sosia, who is, in the language of
the commentators, a protatick personage, that is, as Donatus
explains it, one who appears only once in the beginning (the
protasis) of the piece, for the sake of unfolding the argument, and is
never seen again in any part of the play. The narration being ended,
says Donatus, the character of Sosia is no longer necessary. He
therefore departs, and leaves Simo alone to carry on the action. With
all due deference to the ancients, I cannot help thinking this method,
if too constantly practised, as I think it is in our author, rather
inartificial. Narration, however beautiful, is certainly the deadest part
of theatrical compositions: it is, indeed, strictly speaking, scarce
dramatic, and strikes the least in the representation: and the too
frequent introduction of a character, to whom a principal person in
the fable is to relate in confidence the circumstances, previous to the
opening of the play, is surely too direct a manner of conveying that
information to the audience. Every thing of this nature should come
obliquely, fall in a manner by accident, or be drawn as it were
perforce, from the parties concerned, in the course of the action: a
practice, which, if reckoned highly beautiful in epic, may be almost
set down as absolutely necessary in dramatic poetry. It is, however,
more adviseable, even to seem tedious, than to hazard being
obscure. Terence certainly opens his plays with great address, and
assigns a probable reason for one of the parties being so
communicative to the other; and yet it is too plain that this narration
is made merely for the sake of the audience, since there never was a
duller hearer than Master Sosia, and it never appears, in the sequel
of the play, that Simo’s instructions to him are of the least use to
frighten Davus, or work upon Pamphilus. Yet even this protatick
personage is one of the instances of Terence’s art, since it was often
used in the Roman comedy, as may be seen even in Plautus, to
make the relation of the argument the express office of the
prologue.”—Colman.
Monsieur Baron does not dismiss Sosia here, but brings him on
the stage again; once in the third act, and once in the fourth. Sir R.
Steele introduces Humphrey again in the first act, and also in the
fifth. We are told by Donatus, that in the Andrian and Perinthian of
Menander, which are similar in the plot, the first scene is the same as
in Terence, but that in the Perinthian, the old man consults with his
wife instead of Sosia; and, in the Andrian he opens with a soliloquy.
NOTE 85.
But, here he comes.

It has been objected against many dramatic writers, that they are
guilty of great neglect in first bringing their characters on the stage,
without preparing the audience for their appearance, and acquainting
them with their names; and sometimes it happens that an actor has
been on the stage a considerable time, before the audience know
whom he is meant to personate. Terence’s art is admirably shown in
this particular; a new character scarcely ever appears on the stage
after the first scene, before his name, and character, and perhaps
what he may be expected to say or do, is announced to the
audience. For example, in the Andrian, Act I. Scene I., Simo
describes the occupation and character of Davus before he appears;
and names him to the audience as he comes on the stage. In Act I.
Scene III., Davus introduces Mysis: in Act I. Scene IV., Mysis
prepares the audience for the appearance of Pamphilus: in Act III.
Scene IV., Simo announces Chremes, and Mysis is the nomenclator
of Crito in the last scene of the fourth Act. This rule of preparation for
the next scene was called, among the ancients, παρασκευὴ.
NOTE 86.
How this rascal prates!

Carnifex quæ loquitur. Carnifex, or carnufex, means literally an
executioner: this was one of the most opprobrious epithets used by
the Romans. Of all their public servants, the carnifex was the lowest
in rank: his office extended only to crucifixion, which was never
inflicted in Rome on any but those who were considered as the very
worst of criminals. The person of the carnifex was held in such
abhorrence, that he was never suffered to reside in Rome, and rarely
(though sometimes) permitted to enter the city. Vide Cicero’s Oration
for Rabirius. Carnifex means literally a butcher; and most of the
writers of later ages have used it in that sense.
NOTE 87.
No: I am not Œdipus, but Davus.

This is as much as to say, I am a plain man, I am no reader of
riddles: because Œdipus, king of Thebes, was particularly celebrated
for solving an enigma, which had long baffled the penetration of all
the Thebans. Ancient writers relate the story thus: Europa, the sister
of Cadmus, the first king of Thebes, having been carried off by
Jupiter; Juno, in her jealousy, wreaked her vengeance on Europa’s
family, and persecuted Cadmus and his descendants with the most
inveterate hostility. During the reign of Creon, one of the successors
of Cadmus, Juno sent to destroy Thebes, a dreadful monster, called
Sphinx, which was described as having the face and voice of a
woman, the wings of a dragon, the body of a dog, and the claws of a
lion. This extraordinary monster dwelt in a cave, immediately in the
neighbourhood of Thebes, and seizing every one that ventured to
approach, proposed the following well-known riddle, “What walks in
the morning on four legs, at noon on two, and at night on three?”
Those who were unable to solve the enigma were instantly torn in
pieces; and, as the Thebans were, in general, so remarkable for their
slowness and sluggishness, that they were called “Theban pigs” by
the rest of Greece, it may be readily believed that the monster’s
question long remained unanswered. When the city was in danger of
total demolition, Creon the king offered his daughter Jocasta, and his
crown, to him who should solve the riddle, as the oracle declared that
to be the only means of deliverance. This was at last accomplished
by Œdipus, who replied, that it was man: who crawls in his childhood,
walks upright in the vigour of his age, and who uses a crutch when
he grows old: on hearing this answer, the Sphinx slew herself.
Some commentator on Terence very ingeniously observes, that
Davus, by saying that he is not Œdipus, and cannot understand his
riddle, covertly insinuates that Simo is a second Sphinx.
NOTE 88.
The grinding-house.
Terence has rendered by the word pistrinum, the Greek
σωφρονιστήριον, or house of correction, whither criminals were sent
for the various terms of imprisonment proportioned to their offences.
Slaves, while in this prison, were employed chiefly in grinding corn,
which, from a deficiency of mechanical knowledge, was, in those
times, a very laborious employment. The Athenians, who were
universally celebrated for their kind and gentle treatment of slaves,
were very reluctant to proceed to severer punishments than whipping
or imprisonment: but when a flagrant delinquency rendered it
necessary to make an example, they either burned the criminal with
a hot iron, in the offending member, if possible; or put on his feet a
torturing instrument, called χοῖνιξ. If the law required the criminal to
suffer death, which happened in very few cases, he was either hung,
beaten to death with clubs, or cast into a deep pit, called βάραθρον,
filled at the bottom with sharp spikes. They sometimes had recourse
to other extraordinary modes of punishment: but the before-
mentioned were the most common.
NOTE 89.
In truth, friend Davus, from what I have just heard.

This scene contains the second part of the narration, which
possesses all the requisites enumerated by Cicero, perspicuity,
probability, brevity, and sweetness. It is introduced with Terence’s
usual art, and enough is said respecting Glycera’s birth, to prepare
the mind for the dénouement in the last act. This scene, and that
before it, are omitted in the Conscious Lovers; and a dialogue
between Humphrey and Tom, and another between Tom and Phyllis,
the English Davus and Mysis, are substituted instead of them: but
Phyllis is the servant of Lucinda, the lady Sir J. Bevil wishes his son
to marry: and not of Indiana, the modern Glycera. The two scenes
above mentioned contain only one incident: the conveyance of a
letter from young Bevil to Lucinda, apprizing her of his disinclination
to the match.
NOTE 90.
This affair must be handled dexterously, or either my young master

or I must be quite undone.
The original of this passage is as follows: Quæ si non astu
providentur, me, aut herum pessundabunt. A deviation from the
customary mode of expression sometimes occurs in our author’s
writings. I shall set down the most remarkable words of this nature
that are to be found in this play.
Abutor, with an accusative.

Alterco, for altercor.
Astu, for Astutia.
Complacita est, for placuit.
Catus.
Claudier, for claudi.
Conflictatur, cum ingeniis ejusmodis.
Duint, for dent.
Diecula.
Emergere se, for emergere.
Face, for fac.
Introspicere.
Ipsus.
Immutarier, for immutari.
Morigera.
Maximum facere hominem, for maximi.
Ornati, for ornatus.
Preci, for precibus.
Postillà, for posteà.
Symbola, for symbolum.
Spero, for timeo.
Subsarcinatam.
Tetulit.
Tumulti, for tumultus.
NOTE 91.
If he finds out the least thing I am undone.

Terence has the art of making us feel interested in the favour of
almost all his characters: they insensibly gain ground in our good
opinion: even this Davus, who certainly has a spice of the rogue
about him, creates a warm interest in his favour by his fidelity to
Pamphilus; and his generosity in risking his own safety to serve him:
he braves the threats of Simo, when, by assisting him, and betraying
Pamphilus, he must have secured the old man’s favour, and
consequently great advantages to himself. But very few of the worst
characters in Terence’s plays seem to us to be wholly unamiable.
NOTE 92.
I think their intentions savour more of madness than of any thing
else.
Terence plays upon the words in the original of this passage,
which is as follows,
“Nam inceptio est amentium, haud amantium.”
Literally, For they act like mad people, not like lovers. This pun
cannot be preserved in an English translation, till two words can be
found alike in sound, one meaning “mad people,” and the other
“lovers.” The only attempt in English is the following: but the author
has rather altered the sense.
“For they fare as they were lunaticke, and not lovesicke.”

Bernard.
Terence plays upon words in this manner several times in this

play,
Maledicere, malefacta ne noscant sua.

Solicitando, et pollicitando eorum animos lactas.
Quia habet aliud magis ex sese, et majus.
Quo jure, quaque injuria.
Ipsu’ sibi esse injurius videatur, neque id injuriâ.
P. Quid vis patiar? D. Pater est Pamphile.
The ancients manifested very great partiality for this species of

wit, which the Greeks called παρανομασία and the Romans
agnominatio. The writings of Plautus abound with puns above all
others, and he is thought to have applied them with great ingenuity:
the following may serve as a specimen.
Boius est, Boiam terit.

Advenisse familiares dicito.
Nescio quam tu familiaris es: nisi actutum hinc abis,
Familiaris, accipiere faxo haud familiariter
Optumo optumè optumam operam das.
Though the Greeks and Romans considered puns an ornament to

writings and discourses of all kinds, modern critics have decided that
they ought to be admitted only in writings of a light nature; and that
they decrease the force and beauty of grave and serious
compositions, which ought to wear an air of dignified sublimity,
unmixed with any thing of a trivial nature.
The lines immediately preceding the before-mentioned passages
are thus altered by a French editor. Vide Note 72.
Ad hæc mala hoc etiam mihi accedit; hæc Andria,

Quam clam patre uxorem duxit Pamphilus, gravida ab eo est.
The original lines are,
Ad hæc mala hoc etiam mihi accedit; hæc Andria,

Sine ista uxor, sine amica est gravida a Pamphilo est.
NOTE 93.
Boy or girl, say they, the child shall be brought up.

In the Latin,
Quidquid peperisset decreverunt tollere.
Boy or girl, they have resolved that it shall be taken up. The words
taken up allude to the custom which prevailed in Greece, of
destroying children. This barbarous cruelty was practised on various
pretences; if an infant was, at its birth, deformed in any of its
members, or if it appeared extremely feeble or sickly, the laws
allowed, and even enjoined, that it should be exposed: sometimes
illegitimacy was considered a sufficient cause for the exposure of a
child. Though the parents were generally allowed to choose whether
their offspring should be destroyed or preserved; in some parts of
Greece all the inhabitants were compelled to send their new-born
infants to officers appointed to examine them: who, if they found
them not robust and healthy, cast them immediately into deep
caverns, called ἀποθέται, which were dedicated to this purpose. It
was customary, in Athens, to place a new-born infant on the ground
at the feet of its father, if he then took it up in his arms, it was
considered that he bound himself to educate and provide for the
child: hence, the expression tollere, to take up: but, if on the contrary,
he refused to acknowledge it, a person appointed for that purpose
conveyed it to some desert place at a distance from the city: and
there left it to perish. The Thebans are said to have been the only
people in Greece, among whom this barbarous custom did not
prevail: but the story of Œdipus, a prince who was exposed, though
afterwards preserved, is a proof that they did not altogether abstain
from this practice.
NOTE 94.
To prove that she is a citizen of Athens.

Women were allowed to enjoy the privileges of Athenian citizens,
and, at the building of Athens, by Cecrops, they carried a point of no
less importance than the choice of a name for the new city, in
opposition to the votes of the men. Varro tells us that Neptune
wished the new-built city to be called after his name, and that
Athena, or Minerva, rivalled his pretensions. The question being put
by Cecrops to his people, the men all voted for Neptune, but the
women voted for Minerva, and gained, by one vote, the privilege of
naming the city. The women were wholly excluded from any share in
the government of Athens, in later ages; though they still retained
various privileges as Athenian citizens.
For a further explanation of the rights of the Athenian citizens; and
for some account of the city of Athens, vide Notes 150, 179, 180,
181, 193, 197.
NOTE 95.
Once upon a time, a certain old merchant.

The title of merchant we are to suppose to be added by Davus to
embellish the tale. Neither Chremes nor Phania are described as
merchants. This addition is well managed by the author, as Davus,
who thought the whole a fabrication, imagined he was more likely to
gain credit by telling the tale that way; as a considerable traffick was
carried on between Athens and the island of Andros, which was a
very fertile spot.
M. Baron has translated this scene with great fidelity and beauty.
Davus developes in it a plan to break off the dreaded match with
Philumena, by introducing Glycera to Chremes: which incident is
substituted instead of the birth of the child. There is a break in the
French lines which renders them inimitably beautiful.
“De ce vieillard fougueux pour calmer la furie,
Quoi! Ne pourrions nous pas résoudre Glycérie
A venir à ses pieds lui demander——? Helas!
Glycérie est malade, et je n’y songe pas.”
Baron.
NOTE 96.
Well, I’ll betake myself to the Forum.

A forum, both in Athens and Rome, was a large open space
within the city, dedicated to various purposes. The forum was a place
where the people met for public worship, for the administration of
justice, and to debate on the public affairs. In the Forum, also, were
the temples, hospitals, sanctuaries, and the markets of all kinds: in
short, it was a place of general rendezvous for men of all ranks and
professions, and was, in many respects, very similar to those places
of meeting we call by the name Exchange.
In Rome there were six great forums, 1. the Roman, 2. the Julian,
3. the Augustan, 4. the Palladian, 5. the Trojan, 6. the Forum of
Sallust. In Athens, the principal Forum was called ἀρχαία ἀγορὰ; it
was extremely spacious, and decorated with some very fine
buildings, and statues of eminent persons. There were also many
others, but the most considerable was called the Forum, by way of
distinction.
NOTE 97.
Act I. Scene IV.

Of all writers ancient or modern, except Seneca, Terence was the
most indefatigable in endeavouring to embellish his writings with all
the ornaments that alliteration could give them. It is not my intention
to enter in this place into a discussion of the advantages, or
disadvantages that verses may derive from alliteration; a subject on
which critics differ as widely as they can on any other point. The
practice of many first-rate writers, however, both ancient and
modern, who have thought that alliteration adorned their
compositions, entitles it to attention. Although eminent critics have
argued against this literary ornament, that its success is but a trivial
excellence, I cannot but remark that it is allowed on all sides that
great labour, care, and patience, are requisite, to succeed in
alliteration; which must certainly contribute to render it of some
value, and afford an absolute proof of the excessive labour and
deliberation with which Terence wrote his plays, every line of which
was, as I may say, weighed, before he wrote it down: for no author,
ancient or modern, (with the before-mentioned exception,) ever
employed alliteration so frequently, nor, in my opinion, with better
effect than Terence.
The following lines will afford the reader a specimen of the almost
astonishing extent to which alliteration was used by some of the
ancient authors, Greek and Latin.
I. From Terence.
“Audivi, Archillis, jamdudum: Lesbiam adduci jubes

Sane pol illa temulenta est mulier, et temeraria
Nec sati digna cui committas primo partis mulierem.
Tamen eam adducam. Importunitatem spectate aniculæ;
Quia compotrix ejus est. Diana da facultatem, obsecro,
Huic pariundi, atque illi in alius potius peccandi locum.
Sed, quidnam Pamphilum exanimatum video? vereor quid siet.
Opperiar, ut sciam, numquidnam hæc turba tristitiæ adferat.
Ut animum ad aliquod stadium adjungant, aut equos—
Alere, aut canes ad venandum, aut ad philosophos.
In ignem imposita est. Fletur. Interea hæc soror.
Mala mens, malus animus. Quem quidem ego si sensero.
Ipsum animum ægrotum ad deteriorem partem plerumque applicat,
Nec, quid agam, cerium est; Pamphilumne adjutem, an auscultem
seni.

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Financial Reporting and Analysis 6th

Edition Revsine Solutions Manual

Financial Reporting and Analysis 6th Edition Revsine

Financial Reporting and Analysis 5th Edition Revsine

Financial Reporting and Analysis 7th Edition Revsine

Financial Reporting and Analysis 7th Edition Revsine

International Financial Reporting and Analysis 6th

Financial Reporting and Analysis 7th Edition Gibson

Financial Reporting and Analysis 13th Edition Gibson

Financial Reporting Financial Statement Analysis and

E7-2. Tying contracts to accounting numbers

• Low cost: Since the borrower (company) must produce financial

• Accounting numbers are audited: Since the financial statements are

• Management manipulation: Even though the financial statements are

• Mandatory accounting changes: Accounting-based loan covenants can

E7-3. Debt covenants and accounting methods

Despite these reasons, some lenders do stipulate the accounting method(s)

E7-4. Sunshine Groceries Inc.: Sales-based bonus plan

To encourage managers to increase sales profitably, many companies pay

E7-5. McDonald’s Corporation: Pay disclosure lawsuit

Country club membership is likely to be one of those pay components that

Some companies may be reluctant to disclose pay components of this sort

E7-6. Regulatory costs

Electricity rate regulation provides another example. State utility regulators

Regulatory costs are important for understanding a company’s financial

When “construction in progress” costs are included in the rate base,

Assets in service $3,200 $3,200

Allowed return on assets (8%) $296 $256

Revenue requirement1 $1,416 $1,376

E7-8. Equipment repairs and rate regulation

Assets in service $1,600.00 $1,600.00 $1,600.00 $1,600.00

Allowed return on assets (8%) $128.00 $128.40 $128.00 $128.32

Revenue requirement1 $733.00 $728.40 $728.00 $729.32

Minimum capital requirements affect the financial statements which banks

• There’s expanded disclosure regarding a company’s capital structure and

• Certain “exotic” financial instruments that count as investor capital for

E7-10. Identifying conflicts of interest and agency costs

An agency relationship: whenever someone hires another person (the

The bonus plan rewards managers for increasing earnings—the numerator in

• Overstating revenue for the quarter by forcing retail franchises to

• Understating expenses for the quarter by recording certain operating

P7-3. Medical malprofits

P7-5. Frisby Technologies: Violating a covenant

P7-6. Tying bonus to EPS performance

Basic bonus: 1% of $50 million = $500,000

Basic bonus: 1% of $50 million = $500,000

P7-7. Earnings quality and pay

Consider the three income-reducing special items:

a) Loss on early retirement of debt

(a) Income from continuing operations. The rationale here is to exclude

(b) Income from continuing operations, adjusted for all nonrecurring

(c) Income from continuing operations, adjusted for nonrecurring

For most companies, the best choice is (b).

P7-8. Avoiding debt covenant violations

• Any of the actions outlined in (1) also apply here.

• Issue common stock before the end of the year.

• Reissue treasury stock before the end of the year.

• To reduce the ratio of consolidated debt to total capitalization (i.e., to total

• The last three items could be combined into a stock-for-debt exchange

P7-9. Accounting in regulated industries

P7-10. Understanding rate regulation and accounting choices

Assets in service $3,200.0 $3,200.0 $3,200.0 $3,200.0 $3,200.0

Allowed return at 8.75% $280.0 $295.3 $279.4 $208.3 $285.3

Revenue requirement $ 1,400.0 $ 1,410.3 $ 1,406.4 $ 1,401.8 $ 1,405.3