assignment 1.docx

assignment 1.docx

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assignment1

TheStamfordInternationalIncishavingtroublereachingitsexpectedearninggoalsforthe1stquarter.Basedontheseniormanagement’sdiscussion,$0.52pershareshouldbethefigurethatbestreflectsthecompany’soperatingresultsforthecurrentreportingperiod.ThisfigureiscomputeduponthepreliminaryEPS,whichis$0.47,plusdeferredmaintenancecostandspringrelocationcost,whichamountsto$0.05intotal.Astheseexpenseswereincurredlastyear,theyshouldnotbedeferredandchargedagainstthisyear‘sincome,instead,theyshouldbeaddedbacktothe1stquarter’searningstoreflectthetruefinancialpositionofthecompany.Stamford’smanagementwillnotrevealthisfiguretothepublicforinterimreportingpurposebecauseitisstillbelowmarket’sexpectationandinvestorswillreactnegativelytoit.Tocreateamorefavorableearningspicture,topmanagementsareseekingalternativestomanageearningsthroughmakingvariousadjustmentswithinthescopeofGAAP.Inthiscase,anumberofcontroversialaccountingissueshadcreatedampleopportunitiesformanagementtoinflateearnings.Table-1presentspossiblesolutionsforeachsituationunderearningsmanagement.Aftermakingtheaboveadjustments,thecompanywillreportamuchmorefavorableEPS,whichis$0.63,tothepublicof（seeTable-2）however,]managementmayfeelpressureinsigningthe1stquarter‘sSarbanesOxleycertificationforseveralreasons.Firstly.themisstatementofearningsislikelytoexceed5%ofincome,thuswillhaveamaterialeffectonthefinancialstatements.ManagementworrythatthismaterialityissuewilladdressSEC’sconcernandsubjecttosubstantialpunishment.Secondly,theinternalauditors’reporthasdetectedseveralquestionableaccountingpracticesofTechnologicalProductDivision（Table-3summarizedthereasons）.Oncebecomingawareofsuchfacts,externalauditorswillsuspectthatthecompany’sinternalcontroltobeinadequateandreversetheiropinionoverthecompany’sfinancialreportingiftheevidencethattheycollectturnouttobeunsatisfactory,

UnderGAAP,managementhasdiscretionstochoosedifferentaccountingmethodsanduseaccruals,deferralsandestimatestomanipulatereportedearnings.Forexample,TDD‘smanagerhastheflexibilitytodeferinventorywrite-offcoststothisyearasawaytoinflateearningsoflastyear.

1.Thedivisionmanagersareselfinterested.Asawaytomaximizetheirowncompensation,theyintentionallyabusedaccountingrulesandencouragedquestionablepracticestoportrayafavorablefinancialpictureofthedepartment.Forexample,thedivisioncontrollerhasarbitrarilychangedtheaccountingrulestoclassifyexpensedtoolsasexpenditureswithoutnotifyingseniormanagement.

2.Thecompanydoesnothavestronginternalcontrolandcorporategovernanceoverindividualdepartment.Theyarenoteffectivetodetectmanager’sunintentional

measurementerrorsordetertheirintentionalfraud.

Table-1

AdjustmentstoEPS

ReportedEPS

$0.47

DeferredMaintenance

0.02

HeavyMaintenance

0.02

SpringsRelocations

0.03

OtherOverseasDividends

0.10

RestructuringReversal

0.02

AdjustedEPS

（earningsmanagement）

$0.63

Table-2

Accountingissues

EffectsonpreliminaryEPS

Proposedsolutionsunderearningsmanagement

DeferredMaintenance

+$0.02

Capitalizeanddeferthecosttosubsequentperiod

HeavyMaintenance

+$0.02

Capitalizeanddeferthecosttosubsequentperiodifthemaintenanceserviceimprovethequalityofservice

SpringsRelocation

+$0.03

Capitalizeanddeferthecosttosubsequentperiod

BrazilianDividends

−−−

Recordedasotherincome

OtherOverseasDividends

+$0.10

Recordedasotherincomeiftheycanbereasonableestimated

ItalianSubsidiaryWrite-Down

−−−

Recordedascostofgoodssoldiftheamountsareinsignificant;recordedatoperatingcostsiftheamountsareinsignificant

ItalianSubsidiarLawsuit

−−−

Disclosedinthefootnotes

MajorAdsCampaign

−−−

Expensedthecostinthecurrentperiod

ForeignExchangeGain

−−−

Recordedasothercomprehensiveincome

RestructuringReversal

+$0.02

Recordthereversalasliabilityaccount,chargetherestructuringcostsagainstthereversalandaddtheremainingreversalaccountintonetincome

Table-2

ddiscretiontouseaccrualschooseamongdifferentaccountingmethodstorecognizerevenues,recorddepreciationexepense,defertaxpayments,

firmshavediscretioninchoosingaccountingprinciplesandmustmakeestimatedinapplyingthoseaccountingprinciplesinmostcases.Firmsshoulddisclosesufficientinformationinthefinancialstatementsandnotestoinformusersofthesechoices.Measuringtheeconomiceffectsofafirmactivityoftenrequiresjudgement,estimationandsubjectivity.Theincreaseinthedegreeofsubjectivityalsoincreasesthepotentialforfirmstoreportaccountinginformationthatincludeunintentionalmeasurementerrororintentionalbiastoportraythefirminalightmostfavorabletothefirmoritsmanager.

thereasonwhyislargelyaffectedbydivisionmanagers’personalintergrity.tryingtocreateafavorablepictureoftheirdepartment’sgrowthandmaximizetheirowncompensation,themanagersareinducedtoaggressivelyabuseaccountingrulessandencouragequestionableearningmanagementpractices.

Tocreateoptimalmanagercompensationpayments,manipulatetheircompensation

Toinfluenceshorttermstockpriceperformancetomeetthesecurityanalyst‘sprofitforecastwhichwillenhancethesuccessintheacquisitionnegotiations.

.1.Restructuringreserve

Firmrecordarestructuringliabilityonthebalancesheetandtheassociatedrestructuringasanexpenseontheincomestatementwhenfirmshavecommittedtotherestructuringplanandtherestructuringcostsmeetthedefinitionofliability.Earningsmanagementpermitsfirmstoremainthereserveintheaccountsandabsorblossesastheyoccur.Stamfordchargesactuallossesagainstthereserveaccount,insteadofagainstnetincome.Whenthecontingencyissolved,theremainingamountinthereserveaccountwillbereservedandaddedintonetincome.

2.Foreignexchangegain

Shouldbeincludedasowners’equityaspartofothercomprehensiveincomeandincludedasearningsonlywhenfirmsreceivecashfromforeignunitsandcovertforeigncurrencyintoUSdollars.however,earningmanagementcreateopportunitiesforfirmstorealizegainsandreportedasincomebysellingthesecuritiesatagain

3.Deferredmaintenance

Maintainanceandrepaircostsshouldbeexpensedimmediatelyasincurred.Earningmanagementprovidestheopportunityformanagerstoclassifymaintenancecostsascapitalexpenditures,therefore

4.Heavymaintenance

Classifyascapitalexpendituresanddeferextracoststolaterperiod.

5.majoradvertisingcampaign

GAAPrequiresimmediateexpensingofthesecostsasincurredinthefirstquarter.ReportedaspartofSG&Aexpenseontheincomestatement

6.Braziliandividends

Dividendincomeisreportedasearningsontheincomestatementwhenreceivedordeemtobereceivable.

7.otheroverseasdividends

Reportedasearningsontheincomestatement

8.Italiansubsidiarywrite-down

Reducetheassetaccountofinventory,reportthewritedownofinventoryasanexpenseaccountorcostofgoodssoldaccountintheincomestatement.

Managementjudgmentinthesubsequentexpendituresareacreatesamplyopportunitiesforearningsmanagement.Thecapitalizingvstheexpensechoicehasimmediateeffectsontheincomestatement.Onewaytoincreaseearningsistoclassifyroutinemaintenanceandrepaircostsascapitalexpenditures.thus,investorsmustrelyonmanagement’sintegrityandauditor’smonitoringasprotectionagainstself–interestedmanager’smanipulationsearningsthroughbiasedapplicationofthejudgmentnecessaryinmanysettings.stronggovernanceandauditorreportingofinternalreportingweaknessassisttheaccountingquality.

Aportionofanestimatedannualexpenditurethatmightbeexpensedfortheentireannualperiodmaybeaccruedordeferredattheendoftheinterimperiodasmanagementallocatestheestimatedannualexpensebetweenperiodsonthebasisthatreflectstime,salesvolumn,orproductionactivity.

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