accounting issue

The three analyzed 3,500-4,500 companies a year from 1988 to 2002 trying to “predict” future performance with five models in which historic cash flows and estimates were used to different degrees. The trio concluded that cash flows gave a robust future prediction, but when estimates were added they got little help in predicting future performance.Mr. Lev blamed the fast-changing, complex world, and earning manipulation for the difficulty of making a good estimate.

“Estimates are part of accounting. So the focus shouldn’t be on the number of estimates,” argues Neri Bukspan, chief accountant at Standard & Poor’s,” but rather the objectivity and independence of those making the estimates and those tasked with verifying them.”

To enable investors understand the statement properly, both FASB and its international counterpart are designing standards requiring increased disclosure of how fair values are derived and their impact on profits and balance sheets.

Another important issue faced by a financial accountant is the increasing globalization of accounting standards. Not a recent phenomenon, the globalization process has picked up pace in the last twenty years, promoting independence between economies and promising greater wealth and a decrease in poverty for all economies through the “logic of capitalism” (Clifford, 2000, p. 46). Described as “a worldwide pressure for change” (Granell, 2000, p. 89), globalization has polarized opinion (Engardio and Belton, 2000, p. 43; Stiglitz, 2001; Clifford, 2000, p. 46; Cooper et al, 2003; Tisdell, 2001). It is more than just an economic phenomenon for the developing world, having wide-ranging effects, with both winners and losers. While its benefits are substantial, global capitalism nevertheless has a downside.

By embracing globalization, whole societies are disrupted (Engardio and Belton, 2000), and the cultural uniqueness of nations is threatened by western-dominated ideologies and technologies. At the same time as millions of people benefit from foreign aid which establishes irrigation and education, there are profound changes in legal, regulatory and cultural systems that have been in place for generations. This particularly applies to emerging economies as well as developing countries, as they face significant changes in their cultural, legal and regulatory structures.

Accounting plays a key role in the process of globalization, through the operations of multinational corporations, the regulatory systems of developed countries (Arnold and

Sikka, 2001, p. 476), and the prevalence of international accounting firms (Perera et al,

2003). Consequently, IFRS is both a manifestation of globalization and a technology by means of which globalization is mobilized. In 1973 the International Accounting Standards Committee (IASC) was formed to work towards greater comparability between financial reports across countries (Alfredson et al, 2005, p. 7). Since then, post-reconstitution into the International Accounting Standards Board (IASB), it has grown in influence to the point where it has now almost 100 countries either converging or adopting IFRS (IASB, 2006c) although, significantly none of the 14 members of the IASB is from a developing nation (Jacob and Madu, 2004, p. 359).

The adoption of IFRS produced substantial benefits for the firms, including decreased cost and greater mobility of capital, efficient allocation of resources, improved and more comparable financial reporting, and a decrease in the opportunities for earnings management (UNCTAD, 2005, pp. 5 – 6). These, together with the accountability demands of the World Bank and the IMF (Neu and Gomez, 2006; Stiglitz, 2001, pp. 12 – 13), made a compelling case for the adoption of IFRS by developing countries and emerging economies as they seek to participate in the wealth and financial opportunities promised by globalization.

Another potential issue faced by an accountant is Creative Accounting. Definitions of creative accounting vary, and include the following:-

‘Is the deliberate dampening of fluctuations about “some level of earnings

considered to be normal for the firm”’. (Barnea et al. 1976)

‘Is any action on the part of management which affects reported income and

which provides no true economic advantage to the organization and may in

fact, in the long-term, be detrimental’. (Merchant and Rockness, 1994)

Possible reasons for such accounting practice are as follows:-

To manipulate profit to match forecasts. Fox (1997) reported how Microsoft designed its accounting policies, within normal accounting rules, to match reported earnings to profit forecasts. It deferred large part of the profit, generated from software sales, to future years to cover potential upgrade and customer support costs, thereby the company’s future earnings were predicted easily.

Secondly, Company directors keep an income-boosting accounting policy change in hand to distract attention from unwelcome news. Collingwood (1991) reported on how a change in accounting method boosted K-Mart's quarterly profit figure by some $160 million, by a happy coincidence distracting attention from the company slipping back from being the largest retailer in the USA to the number two slot.

Creative accounting also helped maintain or boost the share price both by reducing the apparent levels of borrowing, so making the company appear subject to less risk, and by creating the appearance of a good profit trend. This helps the company to raise capital from new share issues, offer their own shares in takeover bids, and resist takeover by other companies.

Looking at the reasons above one might wonder the ethics behind these practices.  Revsine (1991) offered some defence for these practices by drawing heavily on the literature of agency theory. He believes that both the management and the shareholders reap benefits from these ‘loose’ accounting standards. On one hand the manager is able to manipulate income so as to maximize their bonus settlements. On the other hand shareholders benefit from the fact that managers can manipulate reported earnings to 'smooth' income since this may decrease the apparent volatility of earnings and so increase the value of their shares. At the heart of this analysis are the following implicit views that:

∙ the prime role of accounting is as a mechanism for monitoring contracts between managers and other groups providing finance;

∙ market mechanisms will operate efficiently, identifying the prospect of accounting manipulation and reflecting this appropriately in pricing and contracting decisions.

As mentioned in the beginning a financial accountant’s vital role is to safeguard the firm’s financial statements from fraudulent manipulations. Increasing globalization, which means adoption of common accounting practices means that the accountant must ensure that the changes are implemented systematically and the protocols are maintained throughout. Estimates and creative accounting are attractive tools for manipulating critical figures and mislead the investors. Whereas these methods have its own advantages, the financial accountant should not forget the mishap it will cause if used improperly. On the whole, in order to perform his task with integrity the financial accountant needs to be proactive in his approach and be critical when analyzing financial statements.

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REFERENCES

• “The ones that get away” – July 28th 2005, New York Economist (print edition)

• Alexander, D. Britton, A. and Jorissen, Ann (2007) “International Financial Reporting and Analysis” – 3rd edition. Thomson

• Alfredson, K., Leo, K., Picker, R., Pacter, P. and Radford, J., 2005, Applying International Accounting Standards, John Wiley & Sons Australia, Ltd, Milton, Queensland.

• Amat, O. Blake, J. and Dowds, J. (1999) “The Ethics of Creative Accounting”, Economics Working Paper,  Journal of Economic Literature classification: M41

• Amat, O. & Gowthorpe, C. “Creative Accounting: Nature, Incidence and Ethical Issues, Journal of Economic Literature Classification: M41

• Arnold, P. J. and Sikka, P., 2001, “Globalization and the state-profession relationship: the case the Bank of Credit and Commerce International”, Accounting, Organizations and Society, 26, pp. 475 – 499.

• Barnea, A., Ronen, J. and Sadan, S.: 1976 ‘Classificatory smoothing of income with extraordinary items’, The Accounting Review, January, pp.110-122.

• Clifford, M. L., E., 2000, “Moving up the ladder”, Business Week, November 6, pp.46 – 51.

 

• Collingwood, H. (1991) 'Why K-Mart's good news isn't', Business Week, March 18:40.

• Cooper, C., Neu, D., and Lehman, G., 2003, “Globalisation and its discontents: a concern about growth and globalization”, Accounting Forum, Vol. 17, No. 4, December, pp. 359 – 364

• Engardio, P. and Belton, C., 2000, “Global Capitalism”, Business Week, November 6, pp.40 – 45.

• Fox, J. (1997) 'Learn to play the Earnings Game', Fortune, 31 July.

• Granell, E., 2000, “Culture and globalisation: a Latin American challenge”, Industrial and Commercial Training, Vol. 32, No. 3, pp. 89 – 93.

• Irvine, H. J. Lucas, N. (2006) “The globalization of accounting standards: the case of the United Arab Emirates” Faculty of Commerce, University of Wollongong

• Jacob, R. A. and Madu, C. N., 2004, “Are we approaching a universal accounting language in five years?” Foresight, Vol. 6, No. 4, pp. 356 – 363.

• Merchant, K.A. and Rocknes, J. (1994) 'The ethics of managing earnings: an empirical investigation', Journal of Accounting and Public Polky, 13: 79-94.
• Neu, D., and Gomez, E. O., 2006, “ The ethics of World Bank lending”, Accounting Forum, 30, pp. 1 – 19.

• Perera, H. B., Rahman, A. R. and Cahan, S. R., 2003, “Globalisation and the major accounting firms”, Australian Accounting Review, Vol. 13, No. 1, pp. 27 – 37.

• Revsine, L. (1991) 'The selective financial misrepresentation hypothesis', Accounting Horizons, December: l6-27.

• Stiglitz, J., 2001, Globalization and its discontents, Penguin Books, New Delhi, India

• Tisdell, C., 2001, “Transitional economies and economic globalisation", International Journal of Social Economics, Vol. 28, No. 5/6/7, pp. 577 – 590.

• UNCTAD, 2005, “Review of Practical Implementation Issues of International Financial Reporting Standards”. Available at:

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