Managers are responsible for making decisions on real issues affecting the earnings and accounting policies within their firms.

Answer

Question 1

Managers are responsible for making decisions on real issues affecting the earnings and accounting policies within their firms. Such decisions aim at achieving pre-determined objectives using aggressive tactics for increasing earnings or profits such as the earnings per share or the overall revenues. This management role is referred to as earnings management (Kieso et. al., 2012). Earnings management presents a certain level of earnings or discloses possible loopholes in the standards of financial accounting. The different types of earnings management include estimates of inappropriate liabilities and accruals, generous accounting reserves and excessive provisions, minor intentional financial reporting breaches linked with material breaches and unsuitable recognitions of revenue. It takes certain patterns such as Big Bath accounting, which occurs when corporations write off some assets in their balance sheets each year. Other earning management patterns are maximization, smoothing, and minimization of a company’s total income (Kieso et. al., 2012). According to Kieso et. al (2012), the motivators for earnings management include political hypothesis costs such as lowering political heat. Contractual motivations such as managing cash bonuses and debt covenants, and earning expectation drivers like an initial public offering, which may be used for negatively affected share prices. Deceptive earnings management influences financial reports users’ perception about profitability and performance leading to financial reporting fraud.

Generally, error and fraud are the only causes of financial reports misstatements. Fraudulent financial accounting refers to preparation of financial statements with the intent of misleading the public. Such misstatements include financial statements disclosures or omissions of amounts aimed at deceiving the users of such financial statements. Factors causing fraudulent reporting range from the misuse of accounting principles to false transactions and distorted records. Fraudulent reporting takes the form of asset misappropriation and misstatement in financial statements and fictitious or premature revenue recording such as revenue overstatements. Understating receivable allowances, recording non-existent assets, and overstating tangible asset inventory values such as plant, property, equipment, and inventory also form part of fraudulent financial reporting (Remley & American Management Association, 2005).     

Some reports of fraud result purely from the company’s situation. For example, it is common for small companies to suffer cumulative fraud amounts. Secondly, most fraud cases overlap in fiscal periods, which can go up to over 12 months. Another situational fraud incentive is the ability to prepare overstated revenue such as using premature and fictitious revenue records and financial statements of assets. Fraudulent financial reporting is prevalent in large companies with enough assets to cover up the fraud practices. In addition, fraudulent financial reporting and earnings management largely depends on a controlled environment. For instance, the company’s top management determines its ability to produce fraudulent reports. According to Elliott & Elliott (2008), findings of the Treadway Commission, show that 72% of fraudulent reporting cases involved company chief executive officers, 43% involved chief financial officers and 83% involved both or one of these parties. Another lead to fraudulent reporting is irregular meetings such as just once in a year of the internal audit committee. From the Treadway Commission findings, 25% of companies lack an audit committee while 65% of the audit committee members were either non-certified or currently out of practice (Elliott & Elliott, 2008). Finally, some company directors are comprised of individuals affiliated by family ties, which means that some people may be accorded incompatible jobs based on family ties resulting in loopholes for committing fraud.

Elliott, B., & Elliott, J. (2008). Financial accounting and reporting. Harlow: Financial Times Prentice Hall.

Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2012). Intermediate accounting. Hoboken, NJ: Wiley.

Remley, J., & American Management Association. (2005). Make million$ selling real estate: Earning secrets of top agents. New York: AMACOM.

Question 2

In the year 2002, the accounting profession suffered because of scandals, which were highly publicized (Epstein & Lee, 2007). For instance, it was discovered that the renowned Arthur Andersen audit firm fraudulently reported false figures about lost funds in the Enron Corporation. This actually led to the corporation filing for bankruptcy. In the same year, the Arthur Andersen firm was also found culpable for attempting to obstruct justice. Because of this, they were sentenced to probationary period of five years and were fined $500,000. In addition, WorldCom was also found to have misappropriated funds amounting to $3.8 billion attributed to expenses. The fraudulent reporting practice occurred in several other companies such as Tyco, Adelphia and Qwest.

According to Kirkwood & Zerbe, (2012), the impact of these scandals on the accounting profession was adverse. The practice negatively affected the public trust in the accounting practice. It also brought to question the effectiveness of the self-regulatory process including whether audit firms still had the moral standing to uphold the public trust. In fact, audit firms ought to give unbiased reports that expose the strengths and weaknesses of each audited company. Audit firms reveal to investors whether the company is making profits or losses (Orth, 2010). The need for regulation in the accounting profession was therefore inevitable as many people were aware of the need to put in place stricter rules that could safeguard the accounting profession. For instance, the Securities and Exchange Commission suggested a number of reforms such as limiting the independence of audit firms that work with big corporations.

It was proposed that the length of time key personnel worked in any given company should be reduced besides regulating the services that audit firms can provide to such companies. Congress passed these new proposals into legislation in summer 2002. The passing of Sarbanes-Oxley Act was the climax of the war on fraudulent accounting reporting. It is said that this legislation was the first significant law that directly regulated the accounting profession since 1933. It is worth noting that regulations have always existed but there was a need for the creation of stricter laws that would save the image of the accounting profession (Financial Accounting Standards Board, 2009). These legislations have had an immensely positive impact on the accounting profession. This is because the laws targeted the big five accounting and audit firms namely, Deloitte & Touche, KPMG, Arthur Andersen, Pricewaterhousecoopers and Ernst and Young. Precisely put, this legislation affected all audit firms as well as all Certified Public Accountants.

References

Epstein, M. J., & Lee, J. Y. (2007). Advances in management accounting. Amsterdam: Elsevier JAI.

Kirkwood, J. B., & Zerbe, R. O. (2012). Research in law and economics: Vol. 25. Bingley, U.K: Emerald.

Orth, J. V. (2010). Reappraisals in the law of property. Farnham, Surrey: Ashgate

Question 3

According to Williams, Carcello, & Neal, (2007), it is crucial that Financial Accounting and Standards Board (FASB), considers economic consequences during the setting of accounting standards. Since its inception in 1973, the FASB was mandated to ensure that appropriate standards were set for financial accounting and reporting. Its primary role was to remain neutral and establish standards that would not only predict cash flows but also assess managerial performance. The FASB statement of concept 1 is based majorly on what external users need from financial statements especially because they lack authority and rely on information from the management. Standards are meant to affect earnings and in turn, the management compensation, financial ratios, debt covenants, stock price, recommendations by analysts and bond ratings (Financial Accounting Standards Board, 2009). Self-serving groups have developed a lot of interest in the setting of accounting standards because of its immense impact. However, this process has been under criticism for being biased. Ideally, this process should be free from politics. The impact of accounting reports on business, unions, governments, creditors, and investors is what is commonly referred to as the economic consequences. The process of setting accounting standards must take note of economic consequences because of its adverse impacts. According to concept 1 of FASB statement, financial reporting must provide information that will be useful to investors, stockholders, and creditors so that they can make informed decisions. It is also important to consider economic consequences of financial standards since the interest of audiences in financial reporting is growing.

References

Financial Accounting Standards Board. (2009). FASB accounting standards update. Norwalk, CT: Author.

Financial Accounting Standards Board. (2009). FASB accounting standards codification. Norwalk, CT: Financial Accounting Standards Board of the Financial Accounting Foundation.

Williams, J. R., Carcello, J. V., & Neal, T. (2007). GAAP guide level A: Restatement and

analysis of current FASB standards. Chicago, IL: CCH