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CREATIVE ACCOUNTING, AUDITING AND REGULATION; ACCOUNTING FOR THE 'OTHERS' Lectures
Veron (September 2009) o 'Doubts are emerging about both global accounting harmonisation and standards quality, measured against the information needs of the financial reporting audience.'
? October 08 - IASB (forced by EU) enabled banks to limit their use of FVA
? April 09 - FASB (under pressure from Congress) - adopted changes to its financial instruments standard allowing banks not to book some of their bad news
? Both boards claimed they would work together on the next steps
But in July IASB published a draft standard restricting scope of FVA while FASB hinted at expandint it o 'The financial system would be better off if convergence was left on the backburner, and the emphasis reverted to truly high quality accounting to meet the needs of capital providers.'
Greene (2008) o 'can mean the valuation is so low the owner has to sell the asset to raise capital' - FVA contributed to financial crisis?
o Alternative? 'Mark-to-funding'
? 'might be possible to redefine it (FVA) such that some of the procyclicality was removed and a clearer view of a company's real financial position given.'
? Companies could choose either to mark assets to market or value them according to their prospective value if held for a longer period of time.
BAA depreciate runways over 99 years - means in effect they ignore the depreciation of runways - but open and consistent
Replacing old equipment?
o Should be an operating cost but creative accounting can mean it is classified e.g. as an 'environmental activity' and written off against assets
Some types of creative accounting techniques o Big bath charges
? Placing large amounts of money into charges associated with company restructuring (alleviates finances from the balance sheet)
When future earnings fall short, these conservative estimates miraculously become income and allow the company to achieve their expected earnings o Creative acquisition accounting
? Companies allocate a large portion of an acquisition price as 'in process' o Cookie jar reserves
? Companies portray unrealistic assumptions when calculating estimates for sales returns, loan losses or warranty costs.
Accruals then hidden in 'cookie jars' during good times and used up during bad times o Materiality
? Occurs when a company intentionally records errors within a defined %
o Revenue recognition
? Increase earnings by recognising a sale prior to the completion of that sale o Round trip technique
? E.g. dot com companies would buy space on one another's networks at the same prices and then count the sales as revenue
No money gained or paid by either firm but improves the look of the books o Slush fund accounting
? Hide some profits from this quarter in case bad results in the next quarter o Banks can change their level of reserves How can you tell?
o One signal of creative accounting is if net income increases but cash flow doesn't
? Although not always the case e.g. accounts receivables could increase because customers don't have the cash to pay; an unforeseen sales slowdown could push inventory levels up
But these could also foretell an earnings slowdown Enron, some facts: o During 2001, each share went from $85 to $.30 o At one point, profits were inflated by $351 million Collier: o 'if, by converting natural assets into more productive assets, a poor society can escape poverty, then it should do so.' o 'In an impoverished society, the future will prefer to inherit schools and cities rather than to remain in impoverished purity.'
? In a rich society, opposite result is likely.
'If we spew out carbon we are obliged not to infringe the rights of the future. We would therefore have to bequeath sufficient man made assets that it feels fully compensated.' o 'But, since the future will be awash with man made assets, the cost of compensation would be exorbitant: better in this case to preserve nature.' Sustainable/ethical investment o 'Too many bandwagon funds are being launched. They look good on first inspection, but when you scratch the surface you find they're investing in companies that would make any discerning ethical investor run a mile.' o 'Do your homework. The gap between the good SRI funds and the bad is too big to leave it to chance.' Hitachi example o Three environmental pillars of our vision:
? Prevention of global warming
? Conservation of resources
? Preservation of ecosystem o Some of their action guidelines
? Technologies and products that take into account the prevention of global warming, conservation of resources and preservation of the ecosystem
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