Examining the multiple types of accounting

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The systematic recording, reporting and analysis of financial statements of the business are called as Accounting. The person in charge of accounting is called as Accountant. Accounting provides the system which provides a system of rules and regulations which govern the format and content of the financial statements.

Following are the methods of financial statements fraud:-

Fictitious Revenues: Recording of the services that did not occur.

Timing differences: Recording revenues and/or expenses in improper methods.

Concealed liabilities: Omissions of liability/expense

Improper disclosures: One form of fraudulent financial reporting is 'creative accounting'

Types of financial accounts:

Financial accounts:

These accounts are used by the company to report to their shareholders. Therefore it should provide a true statement of company's financial position.

Internal management accounts:

Internal management accounts accounts for the internal operations of the business. It shows whether the finance is systematically utilized in the business.

Role of Accountants:

There are basically two types of accountants:

One who works for the company and has an obligation as an employee to the company.

The other who is an independent certified public accountant and may be hired by the company as the outside counsel.

Accountants employed by the organization:

They are divided into two broad categories:

Management accountant

Financial accountant

Management accountant:

The main task of the management accountant is to facilitate the decision making process by providing the relevant information which the company needs for formulating various policies.

If he fails to provide the required information it would affect the long-term objectives of the company.

Financial Accountant:

A financial accountant provides economic information to suppliers, employers and people external to the organization.

The role of financial accountant also involves advising directors on the items that have to be selected for financial statements.

Accountants in Professional practice include:

The auditor

Related services

ETHICAL AUDIT:

Main purpose:

It is to check the actions of the firm, which are directed at maximizing long term owner value and the extent of distributive justice.

Features:

It assesses the business structures and procedures, systems and policies.

It also measures the extent to which the business activities comply with the standards it has publicly declared to its external customers.

It measures the business conduct against the moral or religious standards of the community.

ETHICAL ISSUES IN INFORMATION TECHNOLOGY

Following are the ethical issues that need to be addressed:

Security of the internet transactions

Delivery of the goods

Return of the goods with which the customer is dissatisfied.

Cyber crimes such as:

Hacking

Virus

Software piracy has added to the problems in The Information Age.

To stop all this, parliament passed its first cyber law, the Information Technology Act, 2000, which provided the legal infrastructure for electronic commerce in India.

EXAMPLES:

American Insurance Group

Company Profile:

American International Group, Inc. (AIG) is an American insurance corporation. Its corporate headquarters are located in the American International Building in New York City.

AIG suffered from a liquidity crisis when its credit ratings were downgraded below "AA" levels in September 2008. The United States Federal Reserve Bank on September 16, 2008, created an $85 billion credit facility to enable the company to meet increased collateral obligations consequent to the credit rating downgrade, in exchange for the issuance of a stock warrant to the Federal Reserve Bank for 79.9% of the equity of AIG. The Federal Reserve Bank and the United States Treasury by May 2009 had increased the potential financial support to AIG, with the support of an investment of as much as $70 billion, a $60 billion credit line and $52.5 billion to buy mortgage-based assets owned or guaranteed by AIG, increasing the total amount available to as much as $182.5 billion.

CASE

In this case the Securities and Exchange Commission alleged that AIG's reinsurance transactions with General Re Corporation (Gen Re) were designed to inflate falsely AIG's loss reserves by $500 million in order to quell analyst criticism that AIG's reserves had been declining. The complaint also identifies a number of other transactions in which AIG materially misstated its financial results through sham transactions and entities created for the purpose of misleading the investing public.

It was alleged that in December 2000 and March 2001, AIG entered into two sham reinsurance transactions with Gen Re that had no economic substance but were designed to allow AIG to improperly add a total of $500 million in phony loss reserves to its balance sheet in the fourth quarter of 2000 and the first quarter of 2001. The transactions were initiated by AIG to quell analysts' criticism of AIG for a prior reduction of the reserves. In addition, the complaint alleged that in 2000, AIG engaged in a transaction with Capco Reinsurance Company, Ltd. (Capco) to conceal approximately $200 million in underwriting losses in its general insurance business by improperly converting them to capital (or investment) losses to make those losses less embarrassing to AIG

BERNARD L. MADOFF-PONZI SCHEME

Madoff is a resident of New York City and is the sole owner of BMIS. BMIS' website indicates that Madoff founded BMIS in the early 1960s and that he is an attorney.

Madoff is a former Chairman of the board of directors of the NASDAQ stock market. BMIS is both a broker-dealer and investment adviser registered with the Commission. Madoff oversees and controls the investment adviser services at BMIS as well at the overall finances of BMIS.

The SEC alleged that Friehling and F&H enabled Madoff's Ponzi scheme by falsely stating, in annual audit reports, that F&H audited Bernard L. Madoff Investment Securities LLC's ("BMIS") financial statements pursuant to Generally Accepted Auditing Standards (GAAS). F&H also made representations that BMIS' financial statements were presented in conformity with Generally Accepted Accounting Principles (GAAP) and that Friehling reviewed internal controls at BMIS. The complaint alleged that all of these statements were materially false because Friehling and F&H did not perform a meaningful audit of BMIS and therefore had no basis to form an opinion about the firm's financial condition or internal controls.

Afraid that his work for BMIS would be subject to peer review, as required of accountants who conduct audits, Friehling lied to the American Institute of Certified Public Accountants for years and denied that he conducted any audit work.

The SEC further alleged that Friehling and F&H obtained ill-gotten gains through compensation from Madoff and BMIS, and also from withdrawing returns from accounts held at BMIS in the name of Friehling and his family members.

WorldCom

MCI, Inc. was an American telecommunications subsidiary of Verizon Communications that is headquartered in Ashburn, unincorporated Loudoun County, Virginia. The corporation was originally formed as a result of the merger of WorldCom (formerly known as LDDS followed by LDDS WorldCom) and MCI Communications, and used the name MCI WorldCom followed by WorldCom before taking its final name on April 12, 2003 as part of the corporation's emergence from bankruptcy. The company formerly traded on NASDAQ under the symbols "WCOM" (pre-bankruptcy) and "MCIP" (post-bankruptcy). The corporation was purchased by Verizon Communications with the deal closing on July 7, 2006, and is now identified as that company's Verizon Business division with the local residential divisions slowly integrated into local Verizon subsidiaries

CASE

It was alleged that WorldCom falsely portrayed itself as a profitable business during 2001 and the first quarter of 2002 by reporting earnings that it did not have. WorldCom did so by capitalizing (and deferring) rather than expensing (and immediately recognizing) approximately $3.8 billion of its costs: the company transferred these costs to capital accounts in violation of established generally accepted accounting principles ("GAAP"). These actions were intended to mislead investors and manipulate WorldCom's earnings to keep them in line with estimates by Wall Street analysts.

Starting at least in 2001, WorldCom engaged in an improper accounting scheme intended to manipulate its earnings to keep them in line with Wall Street's expectations, and to support WorldCom's stock price. One of WorldCom's major operating expenses was its so-called "line costs." In general, "line costs" represent fees WorldCom paid to third party telecommunication network providers for the right to access the third parties' networks. Under GAAP, these fees must be expensed and may not be capitalized. Nevertheless, beginning at least as early as the first quarter of 2001, WorldCom's senior management improperly directed the transfer of line costs to WorldCom's capital accounts in amounts sufficient to keep WorldCom's earnings in line with the analysts' consensus on WorldCom's earnings. Thus, in this manner, WorldCom materially understated its expenses, and materially overstated its earnings, thereby defrauding investors.

CASE

Kelsey, a senior accountant at a multi-office CPA firm, is assigned to the audit of Compo Corporation. Compo is a closely held corporation and a major client of the firm. During the audit, Kelsey finds a material cutoff error which causes Compo's income to be significantly misstated. Kelsey is aware that the CPA firm's policy clearly states the audit senior must document any potential material adjustment in the work papers. The final determination of materiality is then made by the partner in charge of the audit. Kelsey also knows Compo does not want to make the adjustment.

Before wrapping up the field work, the audit manager, Bruce, tells Kelsey, Let's not mention this adjustment in the work papers. Since Compo is closely held and there are not tax implications, the partner has decided not to force an adjustment. Compo is our largest client. We need to get the Compo work up to the partner as soon as possible."

Kelsey is concerned and upset after the conversation with Bruce. Failure to document such a material amount just does not seem right.

SOLUTION

This case tells u about the 'COGNITIVE DISSONANCE' of the individual.

Kelly is a senior accountant at a CPA firm.

He is assigned with the duty of auditing Compo, one of the major clients with the company.

While auditing he comes to know that the company has misstated the income.

At this point of time Kelly gets into the dilemma whether to 'FOLLOW THE CODE OF CONDUCT' or to PROTECT the company by not documenting the adjustment.

Failure to document such an adjustment would mean that he is not responsible to the SOCIETY at large.

On the other side if he documents the adjustment he would be FIRED from the company.

CASE

While reviewing the current-year audit working papers of Coshocton National Bank (CNB), the engagement manager, Jennifer Grace, noted something curious. In the working papers related to loan valuation, Jennifer saw that the commercial loan of Fantastic Developments had been randomly selected for confirmation but that Fantastic had not responded to either the initial or second confirmation request.

The audit staff disposed of this "loose end" by alternate procedures: examining cash collections (which had become somewhat sporadic) and vouching to underlying loan documentation, including a set of recent (unaudited) financial statements that showed Fantastic's solid financial position and operating profitability.

Jennifer noted this reference to Fantastic Developments because this private company was also a client of her firm. In fact, Jennifer had served as the audit senior on the prior-year audit of Fantastic. She knew that the company had been struggling for a couple of years and had experienced recurring operating losses. Her knowledge of Fantastic did not reconcile with the discussion in the audit working papers related to the financial statements furnished to the bank.

When Jennifer contacted Fantastic's CFO, Tom Ward, and inquired about the company's apparently miraculous turnaround, he was noncommittal and unhelpful. Tom replied that business had picked up. He apologized for not calling Jennifer's firm himself because he had been so busy, and then he told her that Fantastic had decided to engage another CPA firm for its accounting and auditing needs. Although confused, Jennifer obviously couldn't reject the possibility that this abrupt dismissal was a direct consequence of her inquiry.

As a result, Jennifer wonders whether the financial statements which Fantastic furnished to the bank as a basis for a loan application are fraudulent. The bank apparently has no such suspicion, however.

SOLUTION

In this case Jennifer, the engagement manager notes something curious in the working papers related to loan valuation.

She sees that commercial loan for Fantastic Development has been randomly selected for confirmation

The confirmation surprises Jennifer because she knew that the company was struggling for a couple of years and had experienced recurring operating losses when she used to conduct audit.

When she inquired regarding company's miraculous turnaround she was told by CFO that the company has decided to engage another CPA firm for its accounting and auditing needs.

FROM THE CASE WE CAN SEE THAT PERFORMING THE DUTY CAN PROVE TO BE DANGEROUS SO MUCH SO THAT YOU CAN BE FIRED FROM THE COMPANY

CASE

Maria and Andy worked well together to organize the accounting system and records of a growing Health Maintenance Organization (HMO). Bob and Connie, the two top executives in the HMO, were tightly focused on company growth as it related to monthly and yearly revenue. Bob was also in charge of budget reports.

Every month Maria and Andy would compile financial statements which were reviewed by company officers and later reported in patient and employee newsletters. Oftentimes sales would fall below Bob's original projections. At such times, Bob would rant and rave about the low patient revenue accruals and comment "that surely more must be accrued." Andy and Maria would often remark to each other "why don't we just book the budget," since that is essentially what they did every month after their initial financial figures were reviewed, at least in terms of sales.

Although Andy and Maria realized that at year-end the auditors would not condone Bob's recording practices, they were still somewhat angry that "their" precise accounting system required monthly adjustments because of Bob and Connie's need to "look good to the board."

Of course, when year-end came, the glowing financial news fell short of projections. Although the shortfall was not enough to raise the HMO rates, it did send a panic through the accounting department. This information was not reported directly to shareholders, but it was embarrassing to make the year-end adjustments while scrambling to uncover additional revenues; and explain to coworkers why monthly newsletters were incorrect.

SOLUTION:

In this case Maria and Andy worked well to organize the accounting system and records of a growing HMO.

Andy and Maria would compile the financial statements which would be reviewed by the company officers every month.

Every time the sales figures would fall below Bob's projections because of which he rave about low patient accruals and comment "that surely more must be accrued."

This led to CUMULATIVE EFFECT and when the year ended the glowing financial news fell short of projections which sent a panic to the accounting department.

Lesson learnt: DON'T SACRIFICE LONG TERM GOALS FOR SHORT TERM GAINS

CREATIVE ACCOUNTING

One may think accounting is a clear-cut issue, but creative accounting sure is not. On one hand, creative accounting is not exactly illegal, but on the other hand, it is not exactly widely promoted. The debate gets down to the issue of whether it is ethical or not. To a certain extent, creative accounting does not break any laws, but whether this makes it ethical depends on one's point of view. A main component of accounting is financial statements, where the purpose is to present a fair representation of the company's financial standing.

Managers and accountants can employ creative accounting to significantly skew their financial statements. However, this does not occur with all creative accounting cases-managers and accountants can very well employ creative accounting to the best use for the firm, legally and financially

There is not a set definition of creative accounting, so to clarify, creative accounting in this paper is defined as "a process whereby accountants use their knowledge of accounting rules to manipulate the figures reported in the accounts of a business"

For example, in the case of computing depreciation, managers and accountants have several methods from which they may choose. Some of these are straight-line, declining-balance, and double-declining-balance depreciation. Not only can the managers and accountants select any of the multiple depreciation methods when computing depreciation cost, but they can also pick one method for depreciating one thing, such as buildings, and another method for depreciating another thing, such as equipment (Stice & Stice, 2006, p. 550-553). This depreciation example is just one of the many multiple accounting methods that a company can legally employ. Thus, companies will most likely, if not probably, use the accounting method that will give them their most preferred image.

Another reason why a clear-cut line cannot be drawn on the ethics of creative accounting is that managers and accountants must estimate certain figures in accounting. Not all the numbers are known to the exact decimal place and some numbers are not even known close to the "real" amount, so financial statement preparers must use their best judgment in these cases. Going back to the depreciation example, managers must estimate an asset's residual value and useful life value in order to calculate the depreciation cost. (The residual value and the useful life value must be estimated because management must account for depreciation cost as they are using the asset.

Management only discovers the real amounts of these values when they dispose of the asset, but by this time, they cannot depreciate the asset anymore, so this is the reason they must make the estimates.) Thus, managers could essentially manipulate the depreciation amount to the figure that they want. Technically, this is not illegal because they are within their rights to estimate the numbers, but it could fall into an unethical area if the true values are grossly misrepresented.

Another creative accounting technique that managers and accountants can employ is entering artificial transactions into the financial statements. With this technique, financial statement preparers can manipulate figures on the balance sheet and move profits from one period to another. For example, a company can conduct a "sale and leaseback" transaction where they sell an asset to a third party and then arrange to lease that good back for the remainder of the useful life. Thus, the sale price under the agreement can be "pitched above or below the current value of the asset, because the difference can be compensated for by increased or reduced

rentals" (Amat et al., 1999). This allows the company to legally manipulate their income amount in the financial statements, but whether this is ethical or not is an entirely different story.

There is also a creative accounting technique that can be used by timing when a transaction occurs. Management can time genuine transactions to occur at a period of their choosing. This action is definitely within their rights, and they can choose when they want to act upon it. An example of this method is the timing of a sales transaction. If a company owns a piece of land that is worth $250,000 at historic cost, which is the book value amount on the financial statements, and that piece of land now has a current market value of $950,000, management can choose when they want to sell. They can keep the asset until they want to sell it at a period where they want the company's income to increase. This strategy raises some concerns. On the ethical side, the company has not broken any laws, nor have they overstepped any boundaries, but on the unethical side, in a sense, the company is inflating how well they are doing. So yet again, there is no definitive boundary with the ethics of creative accounting.

Proponents of creative accounting argue that all the examples given are done in an ethical capacity. They claim that the FASB has set the generally accepted accounting principles to give managers and accountants various accounting methods from which they can select. When applying certain methods, the companies are going to choose the ones that make their financial statements better. This is the nature of business-to make the company succeed as well as possible. Creative accounting assists in this endeavor.

On the other hand, opponents of creative accounting see it as "accounting manipulation" (Simon, 1998). The opponents believe that creative accounting is used when managers and accountants want to manipulate the financial statements to show a certain outcome. For instance, when managers want to portray better figures in certain accounts to stockholders, they will employ creative accounting techniques to get their desired results. In these cases, management is most likely not achieving a company's ultimate goal of increasing stock value.

In the short run, the company's stock value might rise due to the numbers shown by the creative accounting, but in the long run, the creative accounting hurts the ultimate goal of increasing stock value because the company cannot employ the creative accounting techniques forever. Since the company cannot continually deceive stockholders with the figures derived by creative accounting, the reality of the situation must eventually be

divulged. When this occurs, this hurts the value of the stock not only at the time, but also in the long run if the

company does not go out of business.

The recent accounting scandals of Enron, WorldCom, Tyco, Adelphia, and the like illustrate when creative

accounting unquestionably becomes unethical and illegal. In these cases, creative accounting was taken to the

extreme. "…The generation of auditors, accountants, and managers present in these companies at the time

of their collapses did not respond correctly or quickly enough when confronted with ethical dilemmas…"

(Jennings, 2004). In the case of Enron, management employed "aggressive accounting" where there was a

total of almost $1 billion in accounting "errors" by the time the company collapsed. Opponents of creative

accounting use this case as an example of why creative accounting should not be employed. However, on the

other hand, proponents argue that Enron is an extreme case and a case where the consequences are not what

creative accounting is intended for. All can see that management was obviously acting unethically in Enron's

case, and creative accounting was unfortunately utilized as a way to achieve their means.

Yet with all the controversy surrounding creative accounting, creative accounting has not been abolished and in

all probability will not be. With the various accounting options and techniques available to financial statement

preparers, creative accounting will always exist. It is doubtful and extremely unlikely that these options will

be taken away so creative accounting must be endured whether it is used in an ethical way or not. Ultimately,

creative accounting should be used if, and only if, it is within the ramifications of the law and it achieves the

company's ultimate goal of increasing stock value. Hence, when using creative accounting, management cannot

just benefit the company in the short run. The creative accounting must also benefit the company in the long run,

which is what ultimately matters.

l Student Bio l

Hailing from Palm Beach County, Florida, Sue Chong is currently a sophomore student at the University of

Southern California, majoring in Accounting. Enrolled in the joint-degree program at the Leventhal School of

Accounting, Sue is working on earning both her bachelor's and master's degrees in four years. Sue is planning

on working in the public accounting industry after she graduates with the eventual goal of becoming the chief

financial officer of a Fortune 500 company.

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