Cookie jar accounting - Coursework Example

? Question One Channel stuffing is a business operation where premature shipment of products to various customers and dealers and thus has an effect on sales by inflating it. Managers of various companies’ products increase the value of their sales by forcing extra products through their supply channel. This can occur as an intentional plan of management in order to increase sales revenue. The incentives as to why managers would resort to extreme earnings management technique such as Channel stuffing include, First is to increase earnings, in given instances, managers and sales personnel are paid commissions and bonuses based on the overall performance of the company and since extreme earnings management technique such as channel stuffing increases sales volumes thereby having a positive result in relation to sales (LAI, et, al. 2009). This increases their earnings. This technique also creates some sense that the performance of the company is well hence in some ways assist in attracting financial institutions and investors to continue investing in the company with a hope of better proceeds (LAI, et, al. 2009). Secondly, these techniques do help a company to have a competitive advantage over their rivals. This is achieved by making sure that jamming effect is achieved for instance constant premature shipment of products into the market (LAI, et, al. 2009). This will give their competitor hard time to sell their products due to so many goods being offered in the market through this technique. Therefore the second reason gives a clear picture of how an organization can benefit from this technique which shows a well organized team of management (BRIGHAM, et, al 2010). Sales maximization will be achieved through these techniques and hence issues related to forecast analysis will be able to be achieved by the company. Thirdly is that the given company will be able to enjoy large scale production of goods and services and also distribute large volumes of the company’s product (BRIGHAM, et, al 2010). The effect of this is that the company will cut down their production costs that are fixed or variable because of the advantages associated with large scale production and hence higher returns (BRIGHAM, et, al 2010). This therefore helps managers in minimizing cost of production by producing and distributing large volumes of goods that results in low cost operations. The effect on this on the financial statement is that the company is guaranteed of good profits as will be reflected on the statements since the main objective of any business is to look for ways of reducing operational cost while maximizing profit (BRIGHAM, et, al 2010). The fourth reason is that the company may want to increase its proceeds from initial public offer. Most companies do raise their capital through initial public offer and so in order to gain the trust from the public, it has to indicate to the public that it is able to make high returns (LAI, et, al. 2009). This is because no investor would want to place its money in the company that will go down very soon. In order to gain such trust, the company has to be able to produce goods and services that can meet the demand in the market (LAI, et, al. 2009). Effectiveness of stuffing the channel from the stand point of a single year From the stand point of a single year, stuffing the channel seems effective because it is hard to detect and given that such can only be identified in the course of full disclosure, such as sales by product, segment, or area. Through careful analysis, the company will be able to reveal abnormal sales patterns. Nevertheless, it is not a guarantee for the company to provide full disclosure unless the auditor insists or as stipulated by (BHATTACHARYYA, H. 2004).  Incase of too much inventory, wholesalers can refuse to stock more inventory since they are not formally company employees. It is also difficult to keep these wholesalers from complaining to regulators. In order to avoid such complaints, the company can resort to paying carrying charges (BHATTACHARYYA, H. 2004). Over a given period of years, this technique is not likely to be effective because of a given number of reasons namely, a)      Storage space might be limited on the wholesalers part b)      The concept of accrual reverse since the goods stuffed in a given time has an impact of reducing sales in the coming trading period. Also when the firm has to maintain the same strategy, it has to do more stuffing. c)      Paying carrying charges for the wholesalers will be costly at the end (BHATTACHARYYA, H. 2004). In general we say that stuffing the channel seems effective in the short run but do lose its effectiveness in the long run. When a company supplies their products in large quantity, they do enjoy reduced cost of production and distribution. The company makes profits in the first year while employees are able to get their commissions, bonuses and remunerations especially if their pay is based on units of goods sold. Suppliers will record revenue anticipated in their income statement. The unearned revenue will be recorded as account receivable in the first year of making sales in the balance sheet. The balance sheet will provide a record of assets inflated by account receivables for that year. The profit and loss account will reflect a huge profit from the credit sales though the amount has not yet been received. In the following years, channel stuffing may result to extra expense to the suppliers of the commodities (MCKAY, et, al 2008). In most cases, when suppliers deliver more products than what is really required within a particular time period, there is probability that retailers may not be able to sell all the products (LAI, et, al 2009). The company may opt to give them some allowances in order to encourage distributors to pay the debts promptly, hence reducing the anticipated earnings from the sales of the previous year. The company will therefore have to document this as an expense hence it will decrease the profits for the following years. Furthermore, if traders realize they cannot be able to sell all products they were supplied with in the previous years, they may decide to return the remaining stock to the supplier (BHATTACHARYYA, H. 2004). This means that supplier will have to incur expenses that can otherwise been avoided had the distributors delivered the exact products required by the retailers and wholesalers during a particular period (MCKAY, et, al 2008). The returned stock will reduce debtors account and sales earnings for the present period but since this has to be reflected in the current period, the company earnings for the current period will reduce hence making company to report little earnings for the present period. The company will also incur enormous cost of maintaining accounts of goods being returned by the marketers and the ones being produced by the company (BHATTACHARYYA, H. 2004). The traders may opt to request for an extension of repayment period for the goods supplied and if the company heeds to their request, the supplier will have to adjust the time the debt was supposed to be cleared. This will affect the earnings of the company due to inflation. They have to adjust the expected income by the inflation factor and this will reduce the value of income reported in the income statement account (TILLMAN, et, al 2005). Finally, traders may be unable to pay for the supplied goods. If this situation occurs, the supplier will have to reduce the assets by amount that was not paid. This will be recorded as bad debt and will be charged in the income statement hence reducing the amount of net income for the company. This may result to closure of the company because of reduction of income for the years that follows sales period (TILLMAN, et, al 2005). Excess delivery of products for material gains by the suppliers is detrimental because in the long run, product marketers may lack financial incentives when products stagnate as a result of over delivery to the clients. This is detrimental to the marketers and the company as a whole because lack of motivation due to failure to meet their target will result to inefficiency. Due to decrease in productivity, the company may end up hiring additional workers hence resulting to reduced performance (HESS, et, al, 2012). Cookie jar accounting Cookie jar accounting refers to a practice by the managers to hold back part of the earnings obtained during a boom period to cater for losses that may occur during seasons with reduced sales. The organization does achieve this by converting an outlay that is indirectly related to any particular accounting period as a liability for a period with better performance (TILLMAN, et, al 2005). The effect of this exercise will be lowering the earnings for the current period, but during the period when the company experiences low returns, they can decrease the reserve liability hence increasing the income reported for that period (HESS, et, al, 2012). This practice has the potential of deceiving shareholders regarding the performance of the venture. Consequently, this will limit the potential of the investors to establish the cause of poor performance of the business during in a particular period hence they cannot get a solution to that problem. Also, it is not easy for managers and other stakeholders to compare the performance of a company over time because the earnings reported for each year does not reflect the accurate value since it is either inflated or reduced. Effectiveness of cookie jar accounting from the stand point of a single year As stated earlier, Cookie jar accounting simply refers to creation of excess reserves for disposals of unnecessary assets and divisions during boom period (TILLMAN, et, al 2005). The excess reserves will be reassigned to reduce expenses involved in operation. Cookie jar accounting appears reasonably effective as an earnings management technique because of its hardship to be detected. The company has its ways of disclosing its proceeds and losses from disposals of assets. Effectiveness of cookie jar accounting over a given period of years When there is over provision for losses, future earnings are placed in the bank and this is against GAAP principles. GAAP does not involve separate disclosure of the effect on operating earnings (BHATTACHARYYA, H. 2004). Full disclosure of abnormal, low-persistence special items may tip off an efficient market as to the possibility of cookie jar accounting. One way of increasing effectiveness of cookie jar accounting is if it is used dependably to make known management’s estimate of persistent earning power. Continuous use of cooking jar accounting over a period of time can lead to its discoveries which can translate to penalties. Implications of cookie-jar accounting During periods of decline in earnings, the management will have to withdraw the amount they had held back from previous earnings to upset decline in income. Therefore, this enables managers to ensure steady earnings for the company (HESS, et, al, 2012). The cookie-jar accounting will enable the company to avoid plunging into debts in order to finance their operations. Therefore, the amount managers save form boom periods are used to meet some of the costs incurred during hard economic times. This ensures steady income for the organization. However, cookie-jar accounting creates false impression about the manager’s performance and in some cases result to earnings of the mangers during period when loss was prevalent (HESS, et, al, 2012). This is favorable to the managers that are being paid for the good work of previous periods. However, this is detrimental to the investors since they are not able to understand wholly the existing mark et t rend of their company’s products. Question Two Impairment of assets is a managerial approach of valuing assets at a price which they expect to sell those products in the market inclusive of all expenditures they may incur in order to get the products sold (LAI, et, al, 2009). Impairment of assets is carried for every individual item that are expected to generate income for the company to ensure the actual value at which the products do not earn less than income what was actually reported and recorded in the book. The management should examine all assets at the end of trading period to establish whether there the assets reflects the actual value or whether there is an increased value (LEUZ, et, al 2004). In case the assets depict possibility of price that is higher than the actual value, the management should work out the value of each individual asset to establish the fact regarding their true value. There are both interior and exterior factors that may depict a possibility of impairment of the assets. Impairment loss Impairment loss is deemed to occur when the market value of the assets after deducting amassed depreciation and impairment loss falls below the net book value of the assets (MCKAY, et, al, 2008). Impairment loss also occur in the condition where the net book value of the assets after deducting accumulated depreciation and impairment loss is above the market value of the assets due to inflated goodwill of the assets. Should impairment loss occur, then the company should adjust the situation by deducting the impairment loss from the net value of the assets otherwise referred to as carrying amount. Companies should carry out impairment in case the market value of the assets has reported a decline (MCKAY, et, al 2008). This is because the company had assessed the value of their assets based on the previous market price; a decline in market price will cause impairment because the book value of the assets will remain greater than the current market value. If the market interest rate hikes it will result to increase in the cost of the assets (LAI, et, al, 2009). This increase will reflect a decline in market value of the asset hence there is need for the company to adjust the value of the asset downward in order to match with the current market rates. A decrease in market value of the company’s stock will create need for the company to readjust the value of their assets in order to match the new market price of their stocks. This is because the worth of the company’s stock in the market is determined by the value of the assets. Therefore, in order for the assets to reflect the actual market value of their stocks, they should match it with the company’s assets by adjusting the accordingly. In case of variation in market conditions such as expertise, financial or regulations that negatively affects the business; the company should examine the value of their assets in order to establish the impact this change in the market factors may have on their assets value. In most cases, such variations in market conditions will cause a decrease in value of the assets hence the company should impair their assets to avoid reflecting a misleading value at the end of trading period. Normally assets experiences normal loss of value as a result of change in knowledge, tear and wear (LEUZ, et, al 2004). This results to a decline in value of the assets from time to time. Therefore, the management of the company should examine the value of assets after specific time period in order to ensure that the value reported in the books of account are the actual value after adjusting for depreciation. Sometimes the company states the value of the assets according to prevailing financial conditions (LAI, et, al, 2009). However, most of the time economy experience financial depression hence resulting to a general decline in value of the assets (LAI, et, al, 2009). Under such a situation, the company should readjust the value of their assets to ensure they reflect the current economy. As a result of this, the company decided to impair their consolidated equity in accordance to discounted future cash flows (BETTY, 2002). Work citations ADELMAN, P. J., & MARKS, A. M. (2009). Entrepreneurial finance. Upper Saddle River, N.J., Prentice Hall BRIGHAM, E. F., GARPENSKI, L. C., & DAVES, P. R. (2010).Intermediate financial management. Mason, OH, South-Western. BETTY, B, ROBERT, A, MAUTZ, & DAVID, R 2002, the Proliferation of "Special” Accounting Items: A Threat to Corporate Credibility, Southern Business Review, CAMFFERMAN, K & ZEFF, S 2007, Financial Reporting and Global Capital Markets: A History of the International Accounting Standards Committee, 1973-2000, Oxford University Press, New York. HESS, E & LIEDTKA, J 2012, the Physics of Business Growth: Mindsets, System, and Processes, Stanford Briefs, Stanford, CA. LAI, G, DEBO, L., & NAN, L. 2009, Manager Incentives for Channel Stuffing with Market- based Compensation1. Working paper, Carnegie Mellon University, Pittsburgh, LEUZ, C, PFAFF, D & HOPWOOD, A 2004, The Economics and Politics of Accounting: International Perspectives on Research Trends, Policy, and Practice, Oxford University Press, Oxford. MCKAY, H, & SHANK, P 2008, Business Words You Should Know: From Accelerated Depreciation to Zero-Based Budgeting--Learn the Lingo for Any Field, Adams Media, Avon, MA. TILLMAN, R & INDERGAARD, M 2005, Pump and Dump: The Rancid Rules of the New Economy, Rutgers University Press, New Brunswick, NJ. BHATTACHARYYA, H. (2004). Working capital management: strategies and techniques. New Delhi, Prentice-Hall of India. Read More