Management Accouting

UV1757

Rev. Nov. 11, 2013

ASSESSING EARNINGS QUALITY: NUWARE, INC.

Jack Hereford finished his second cup of coffee and flipped through the Nuware research

file. He had been asked by Harry Malone to provide a “restatement” of Nuware’s fiscal 2013

earnings, but unfortunately he had only a slight notion of how to proceed. Nuware was a midsize

retailer based in the Midwest, and one of Wyburn Malone’s largest institutional clients was

interested in taking a substantial equity position in the company. One basis for the potential

purchase was Nuware’s continued earnings growth, particularly during a relatively difficult

three-year period for the retail industry. As of its most current fiscal year, Nuware continued to

show solid gains in both earnings and share price.

As was typical of any new research project conducted at Wyburn Malone, a first

objective was an attempt at quantifying whether management leaned toward aggressive or

conservative accounting policies. Hereford felt somewhat uncomfortable delving into any firm’s

accounting policies; he was not an accountant by trade, and moreover, this was only his second

week at the firm. He clearly recognized the importance of this task, however, as many of the

firm’s clients depended on Wyburn Malone’s investment analysis. Moreover, if in the end their

final report indicated significant over- or undervaluation, Nuware might be profiled in Wyburn

Malone’s next newsletter.

Wyburn Malone

Wyburn Malone was an independent equity research firm servicing more than 40

institutional clients, each of whom had an annual subscription to the company’s newsletter—the

WM Report. The WM Report was published six times per year and concentrated on generating

approximately 10 new target investment ideas, both long and short. Quality, rather than quantity,

was the primary objective of the firm’s research function. Recommendations generated by the

research staff virtually always began with a thorough analysis of a...