Generally Accepted Accounting Principle for Company's Internal Control - Research Paper Example

? Capstone Research Project 5) Table of Contents Table of Contents 2 0 GAAP 4 2.0 Leases on Technology Assets Seem Inflated 5 2 Current Lease Accounting 5 2.2 Consequences 6 2.3 Red Flags 6 2.4 Recommendation 7 3.0 E-Commerce state tax payments 7 3.1 Consequences 7 3.2 Red Flags 8 3.3 Recommendation 8 4.0 Fictitious Employees Receiving Post-Employment Benefits 8 4.1 Consequences 9 4.2 Red Flags 9 4.3 Recommendation 9 5.0 Concealing Inventory Shrinkage because it seems Low for the Industry 10 5.1 Consequences 10 5.2 Red Flags 10 5.3 Recommendation 11 6.0 Hiding Cash in Order to help in Future Quarters Where Earnings do not meet Analyst’s Expectations 11 6.1 Consequences 11 6.2 Red Flags 12 6.3 Recommendation 12 References 13 1.0 GAAP Generally Accepted Accounting Principle (GAAP) has changed its module over the course of time. Key aspects of GAAP are mentioned in the following section. GAAP is used to present comparative financial statements in report format while major focus is given on multiyear financial statement. GAAP rule works in connection with SEC rules for public companies. GAAP rule emphasizes on covering financial statements presented in balance sheet for at least three years. GAAP need to work closely with SEC regulations in order to measure performance of companies. In accordance to GAAP guideline interim periods must be viewed as essential part of financial year. This guideline helps accountants to allocate cost elements for different financial period. GAAP also focuses on examining unscrupulous transactions in order to identify financial frauds. Although GAAP rules differ on the basis of accounting standards of different countries. Financial fraud is multi dimensional event in terms of variety of impact and nature of fraud. In many cases financial analysts of companies intentionally forecast inflated market capitalization value in order to fulfill dubious objective. Companies practicing unethical business tend to violate GAAP rules in order to gain personal objectives. Financial fraud can impact various issues such as trade and sales, stock market valuation and investment banking contracts significantly. Many companies use street earning method to calculate earnings per share (EPS) while the method excludes important elements of accounting such as unusual items, extraordinary charges, Charges from mergers and depreciation (Ponzio, 2010, p. 32). Fraudulent companies change GAAP rules in accordance to their requirement in order to satisfy personal objective. Following section will try to explore relationship between GAAP rules and situation mentioned in the Capstone Research Project. 2.0 Leases on Technology Assets Seem Inflated 2.1 Current Lease Accounting GAAP suggests that Current Lease Accounting standard needs to classify their contract as operating lease (all leases except capital lease) or capital lease (this type of lease transfer risks as well as rewards to lessee due to ownership). Amount of capital lease such as payment of rental can be identified from examining the balance sheet. GAAP rule suggests that auditor needs to check capital lease by applying depreciation on assets while such thing is not possible for operating lease. According to GAAP in operating lease the lessee does not realize the amount of leased asset from balance sheet but the person can recognize operating lease expenses. Auditors have criticized the shenanigan approach of GAAP to ignore operating lease. Current lease accounting standard has not identified any special measure in case excessive operating lease. Sometimes operating lease can give rise liabilities such as rental payment hence auditors try to capitalize leased assets. Accountants need to follow criteria specified in ASC 840 (SFAS 13) of GAAP to investigate capital lease. According to GAAP rules capital lease needs to follow (ASC 840-10-25-1) (SFAS 13.7) guideline. Accountants need to check proper valuation of leased property in order to identify financial fraud. According to GAAP rules leased tem should not be less than seventy five percent of economic life of the property. Present value of lease payment should not be less than ninety percent of fair value of property while lessor needs to retain investment tax credit for the ongoing financial year (Bragg, 2007, p. 291). This section of GAAP rule will help the accountant to identify inflated leases on technology assets. From the case study it is clear that actual value of lease payment is less than 90% of fair value but the company showed inflated figure.   2.2 Consequences The company practiced unethical transactions such as recognizing revenue from service, supplies and maintenance at current period. Revenue from leasing activity should be documented at current period and cost of interest should also be realized during leasing period. The company is showing inflated financial reports to shareholders hence they can face financial fraud charges from SEC or Securities and Exchange Commission of USA. To avoid future embarrassment the company needs to release their income statement on the periodic time frame basis. 2.3 Red Flags Customers of the company can raise Red Flags in terms asking questions on actual billing amount, cost of equipment and fair value of leased items. Management team (such as board of directors, shareholders, external consultants) including lessees’ will be answerable to customers. 2.4 Recommendation Companies need to adopt internal controls to take corrective measures to solve the problem. Accountants need to conduct audit periodically in order to prevent the company from producing inflated financial report. Hiring external audit firm can also help the company to get a transparent balance sheet report. 3.0 E-Commerce state tax payments Many companies have done e-commerce fraud in order conceal their unethical trade practice with the help of digital technology. US GAAP can be used to expose e-commerce state tax payments fraud in terms of both future tax effect and current tax consequence (Qin, 2008, p. 200). Company is doing e-commerce fraud in terms of misrepresenting (read understating) their income amount to state government in order pay tax lower than actual amount adjusted to actual income. Companies use specialized software or virus to infiltrate into system security section and then hack important information or steal money. Research scholars have found that issues like pressure, opportunity and rationalization can motivate companies to practice financial frauds. In case of digital medium issues like pressure and rationalization cannot be justified due to low involvement of personal contact. Only way to prevent e-commerce fraud is decreasing the opportunity dynamics by implementing stringent security systems to prevent hackers. 3.1 Consequences Companies practicing e-commerce fraud can be judged under internet protection act. Alleged company needs to pay financial penalty to state government. 3.2 Red Flags State government can raise red flags on fraudulent activity of the company. Management team (such as board of directors, shareholders, external consultants) and computer programmer will be responsible to answer questions raised by state government. 3.3 Recommendation The company needs to adopt following business controls to prevent e-business frauds. Controlling the environment means setting guideline for top managers to behave ethically and not encourage any type of unethical trade practices. Analyzing the risk is associated with financial fraud such as legal investigation, defamation and in worst case scenario complete liquidation and then decreasing the risk propensity by removing risk elements from internal system. Measuring individual performance and designing individual specific job can be classified as control measurement. Communication information regarding fair trade practices can also boost moral as well as ethical efficiency among employees. Monitoring e-business activities by supervisors can be useful in terms of reducing chance of financial frauds. 4.0 Fictitious Employees Receiving Post-Employment Benefits In accordance to GAAP, employer needs audit post retirement benefit cost offered to retired employees. GAAP also issued guidelines such as calculating the present value of post retirement benefit cost with the help of actuarial methods. In many cases employers create fictitious employees in order to manipulate accounting system. Company shows fictitious employees as their present employees in order to show fixed overhead more than actual one. These kind of fraudulent activities help the company to show low profit margin in contrast to actual profit margin earned. External auditors need to check payment records in comparison to existing human resource documents. 4.1 Consequences Companies practicing financial fraud related to fictitious employees might face legal proceedings by external auditors or government (Wells, 2011, p. 214). 4.2 Red Flags There should not be any kind of income tax withholding for fictitious employee. Careful observation will reveal abnormalities regarding health insurance, provident fund and salary reimbursements. There should not be charges regarding holidays, vacations or any kind of personal time out for fictitious employees. Abnormalities will be found after matching employee information with logical database of the company. 4.3 Recommendation External auditors need to investigate existence of the employee by checking their performance report, government issued identity card and daily work report. Auditor needs to conduct personal interview of various persons such as payroll manager, human resource manager and other mid management employees in order to explore the identity of fictitious employees. External auditors need to force the company to pay tax on contribution made by the company by creating fictitious employees. 5.0 Concealing Inventory Shrinkage because it seems Low for the Industry Companies use inventory fraud in terms concealing inventory shrinkage from external members of industry. Companies overstate inventory condition in order to increase bottom line for current year. Companies can defer current period loss caused by inventory shrinkage into next period. Concealing inventory shrinkage in the current might look profitable for short term but ultimately it increases tax liabilities in long run (Heimler, 1993, p. 56). Inventory control can be done by controlling three types of inventories such as raw materials, finished goods and semi finished goods. Controlling inventory also helps the managers to increase production efficiency and capital expenditure. 5.1 Consequences Some companies use incentive payment to production workers which ultimately leads to financial fraud. Workers tend to over report about the stock in order to earn more money. In such cases companies incur huge financial losses. 5.2 Red Flags Company mentioned in the case study can earn higher earnings due to inflated inventory valuation. Production staffs should raise red flag against the unscrupulous inventory policy of the company. 5.3 Recommendation The company needs to adopt proper inventory management in order to decrease inventory frauds. They can implement radio frequency identification technology to track down exiting inventories and monitoring every stages of value chain (Hill & Jones, 2009, p. 293). The whole process will not only decrease chance of financial fraud but decrease holding cost also. 6.0 Hiding Cash in Order to help in Future Quarters Where Earnings do not meet Analyst’s Expectations The company is suspected for using illegal transaction method like bill and hold in order to help in future quarters where earnings do not meet analyst’s expectations. In bill and hold method customers furnish orders in present quarter but they take product delivery in next quarter and in this circumstance fraudulent companies record revenue of future transaction in current quarter (Bragg, 2002, p. 225-226). Using bill and hold method to show inflated earning result is illegal in accordance to GAAP rules. 6.1 Consequences Companies hide cash in order to meet market expectation of future quarters but this process ultimately increases pressure on top management. Showing false financial earning statement for consecutive quarters might lead to bankruptcy in future. The company can learn from same kind of financial fraud committed by Nortel network of Canada. External auditors can expose the cash hiding activity of the company and in future as a result total market capitalization of the company might get shattered. 6.2 Red Flags Investors can raise red flags regarding dubious income statement issued by the fraudulent company. All investors might ask for real earning statement to the company while in worst case investors might ask for resignation of top management team. 6.3 Recommendation The company needs to follow GAAP rules to prevent financial frauds. Top management of the company should not indulge in unethical trade practices such as street earning, bid and hold and hiding cash activities in order to achieve sustainable growth in future. The company also needs to regulate over valuation of equity in order to decrease opportunity dynamics of financial fraud. There should not be illogical gap between market price of the share and its underlying value. Internal control in terms of providing business education to top management people is needed in order to stop future financial fraud. Generally most of the top level executives are from top universities but it has been seen that over the course of time they tend to forget basic business education due to work pressure. Sometimes top level executives commit financial fraud unknowingly hence in such cases they need to consult books regarding business ethics in order to find right way to do business. The company can organize weekly knowledge session regarding business ethics for working executive. Increasing moral ethics among top level executives is a potential way to decrease probably of committing financial fraud by them. References Bragg, S. M. (2002). Accounting reference desktop. Hoboken, New Jersey: John Wiley & Sons. Bragg, S. M. (2007). Wiley GAAP policies and procedures. Hoboken, New Jersey: John Wiley & Sons. Heimler, A. (1993). Empirical approaches to fiscal policy modeling. Berlin: Springer. Hill, C., & Jones, G. (2009). Strategic management theory: An integrated approach. Stamford, Connecticut: Cengage Learning. Ponzio, J. (2010). F wall street: Joe ponzio's no-nonsense approach to value investing for the rest of us. New York: Adams Media. Qin, Z. (2008). Introduction to e-commerce. Berlin: Springer. Wells, J. T. (2011). Corporate fraud handbook: Prevention and detection. Hoboken, New Jersey: John Wiley & Sons. Read More