Accounting Questions - Assignment Example

ACCOUNTING QUESTIONS + Submitted Accounting Questions Question 4: because the mechanisms that limitmanager’s ability to distort accounting data themselves add noise, it is not optimal to use accounting regulation to eliminate managerial flexibility completely. Managers have a variety of incentives to exercise their accounting discretion to achieve certain objectives. a) Explain the incentives to managers to exercise accounting discretion in the way alluded to above. Senior managers can employ the use of diversified methods to raise or lower the net income reported in the bank. The three main categories of methods include accounting fraud, real earnings management and accounting discretion. (Huizinga and Laeven 2009). Every method however has its shortcomings and advantages. Accounting discretion takes place since the financial statements require many discretionary decisions concerning the choice of the methods of accounting as well as valuation of every asset of the firm (Huizinga and Laeven 2009). Managers are hence in a position to execute this discretion since the financial statements of a firm are the accounts of management. The auditors have a mere function of attesting that the preparation of the statements was made in accordance to the generally accepted accounting principles (Huizinga and Laeven 2009). Therefore, whenever the generally accepted accounting principles need judgment, these financial statements mirrors the decision of the managers pertaining to the auditors approving that the decision are within the limits set by the generally accepted accounting principles (Huizinga and Laeven 2009). Accounting discretion method has a significant merit that it does not negatively affect the cash flows of the firm. However, its disadvantage is that the highest amount of earnings by the manager is controlled by the discretion range allowed under generally acceptable accounting principles (Huizinga and Laeven 2009). b) Explain the UK regulatory framework of financial reporting All the United Kingdom financial services and markets are regulated by a non governmental, independent quasi judicial body known as the financial service authority (Quaglia 2007, 278). This body is called the United Kingdom listing authority in its role as a proficient power for stock listing on a stock exchange. This body keeps the official list of securities traded on the regulated markets of the United Kingdom as investment service directive defines (Quaglia 2007, 278). Initially, the United Kingdom monetary service industry was totally self regulating. The regulative authority was distributed across several bodies. In 1985, the securities and investment board got integrated and accorded some legal regulatory powers below the economic service act of 1986 (Quaglia 2007, 279). Due to the decline of Barings bank, the decline of self directive occurred and regulatory accountabilities were incorporated within securities and investment board. In 1997, this became the financial service authority which presently executes legal powers legislated in markets and financial services act of 2000 (Quaglia 2007, 279). c) Critically evaluate the assertion above that it is not optimal to use regulation to eliminate flexibility Where rules lack, managers may try to disclose information that is biased. The company may hence require professional resolve. It is not always that the managers apply the standards of accounting in good faith. Rather, they tend to be biased. Following the flexibility of principles the increment of potential for earning management is criticized (Quaglia 2007, 286). Coming up with appropriate resolve may be difficult since auditors find it challenging, predicting how rules will be made use of in some litigation. Despite the demerits of rule based, various standard setters are likely to opt for rules rather than principles just to avoid litigations and uncertainties (Quaglia 2007, 286). Accounting has therefore not been in a position to get a complete regulatory pack which can give a theoretical foundation regarding the financial accounting domain. The individualistic method of forming these theories has failed since it misses out on some pertinent factual information (Quaglia 2007, 286). A number of challenges have come up to the accounting domain as a result of globalization. Many companies have developed their systems from labor-intensive to digital systems. Therefore, regulators encounter a rising problem of coming up with regulations that guarantee the confidentiality and integrity of the accounting information. Question 5 a) Explain the process by which analysts use in evaluating and, if necessary adjusting for, accounting quality issues in published financial statements. Analysis of financial statement involves comprehending the profitability and risk of the business by analyzing reported financial information (Livingstone 2009, 22). Various accounting procedures and techniques can be used to analyze financial statements. The processes include: formulating reported financial information; with regards to the income statement, one major formulation is dividing reported items into usual or recurring items and unique or nor recurring items (Livingstone 2009, 22). After this is done, earnings can easily be divided into transitory earnings and core or typical earnings. The concept is that normal earnings are more permanent and consequently more applicable for prediction as well as valuation (Livingstone 2009, 22). Normal earnings in addition, are estranged into net financial costs and net operational profit after taxes. The balance sheet for example, is grouped in net financial debt, net operating assets or equity. The second process is the adjustment of measurement errors (Livingstone 2009, 23). This questions the validity of reported accounting numbers. For instance, the reported numbers can be a noisy or bad representation of the capital invested, in terms of say net operating cost. This means that the return on net operating assets will be a bad measure of the original profitability. An example for a modification for measurement error is whereby the analyst gets rid of the R&D expenditures into the balance sheet, from the income statement (Livingstone 2009, 23). These expenditures are then substituted with amortization of the R&D assets in the balance sheet. The third process is analyzing the financial ratios (Livingstone 2009, 23). This is done based on adjusted and regrouped financial statements. It entails analysis of profitability and analysis of risk. Risk investigation aims at finding out the underlying credit risk of the business. It entails solvency analysis and liquidity analysis (Livingstone 2009, 23). Liquidity risk scrutiny entails focusing on ratios like interest coverage and current ratio. Solvency analysis seeks to gauge whether the firm is financed to be able to recover from a period of losses (Livingstone 2009, 23). Profitability analysis analyses the return on capital. It uses insights from financial statements. b) Identify and clarify two specific accounting policies relating to assets and two relating to liabilities which might be of particular concern to study and explain how these might impact on accounting quality. Accounting policies refers to the specific accounting principles and the how they can be made use of in preparation and presentation of financial statements (Christensen Demski and Frimor 2002, 1080). To record an asset divestiture, the asset account is credited by the book keeper to bring it back to zero. The cash account is however debited (Christensen Demski and Frimor 2002, 1080). The two asset-related accounting policies include depreciation and divestitures (Christensen Demski and Frimor 2002, 1080). Depreciation is frequent in fixed asset accounting. Fixed assets allow the corporation to win economic competition over a period more than one year. Businesses pay attention to short term assets to avoid diversion of resources from long term strategies by departmental heads (Christensen Demski and Frimor 2002, 1080). Asset divestiture or asset sales entail the culmination of days or months of strategic thinking. Top management seeks the feedback of segment chiefs and departmental heads before selling assets. This back and forth method allows senior executives to ensure all the facts for making decision are in place (Christensen Demski and Frimor 2002, 1080). Liability related accounting policies include bad debts and insurance. Bad debt is a liability that is likely to be paid by the borrower. It represents the amounts that can’t be recovered from customers by the firm (Christensen Demski and Frimor 2002, 1082). These defaulting clients may fail to pay as a result of temporary financial problems or even bankruptcy. To record bad debts, the bad debt expenses are debited and the allowances for doubtful items are credited. Insurance is a product liability risk covered under a general liability policy (Christensen Demski and Frimor 2002, 1082). The risk may incorporate property damage or bodily injury by indirect or direct actions of the insured. Question 6: The purpose of business strategy analysis is to identify key profit drivers and business risk, and to assess the company’s profit potential at a qualitative level. a) Explain the process and key factors used in business strategy analysis. Business analysis takes into account six factors of scrutiny (Healy and Palepu 2007). The first step is product promotion focus. The primary capabilities in implementing the selling strategy of products are technologies, processes as well as the market access possessed by the firm (Healy and Palepu 2007). These addresses the key success factors of the business. Business strategy entails customer targeting, technical capabilities, product lines as well as positions, market access and strategic processes (Healy and Palepu 2007). Business strategic analysis involves: describing the customer targeting strategy as well as its requirements. It is not possible to develop appropriate products or services that meet the respective needs and aspirations of the customers without targeting a particular customer segment. The second stage is describing the product line and positioning strategies for the identified market segment (Healy and Palepu 2007). The business must make a decision on the goods and services it will offer and how to place the goods or services in competitive markets. The third step is identifying the technologies needed to implement the product market strategy (Healy and Palepu 2007). Technologies offers the primary capabilities required to develop goods or services. It also entails the associated procedures employed in developing and delivering the product in the market. It hence determines the range and speed of delivering goods to the market. The forth step is identifying the strategic processes needed to put into practice the product market strategy (Healy and Palepu 2007). These can either improve the marketing capabilities of a business or the product. These processes are the competitive strengths and weaknesses which form the main competencies of the business. The last step is identifying the market access strategy (Healy and Palepu 2007). A business must be accessible to its customers. Currently, the new channel for accessing markets is the internet. b) Explain how the information provided in annual reports of UK companies can inform this analysis. The data provided in yearly reports of the United Kingdom companies are critical in analyzing the strategies of these companies, since they reveal the critical information required to strategically analyze a business. For illustration, the annual report of these companies shows the technology that has been made use of in production and delivery of goods. It also provides the information on the market focus and accessibility of these companies. All these factual information are considered pertinent in analyzing the strategy of business (Guthrie et al 2004, 287). Question 6: Explain the nature of the narrative reports included in the annual reports of UK listed companies and critically evaluate the usefulness of these narrative reports in assessing corporate strategy. Narrative reports offers a description of the non financial information incorporated in the annual reports to provide a broad and meaningful image of the business, its strategy, market position, future prospects and performance (Linsley and Shrives 2006, 392 ) It includes the chairman’s statement, the director’s report, the director’s remuneration report and the disclosures of corporate governance. Narrative reports may consist of non financial or financial metric. It may also incorporate both financial and non financial metrics (Linsley and Shrives 2006, 392). Generally, it includes both numerical and narrative data. Narrative reports occur in many forms, for illustration, management commentary, analysis and discussion, business appraisal, environmental statement, health and safety disclosure among others. Within the United Kingdom, companies are controlled by the financial reporting standards, issued under the financial reporting council. This financial reporting council is a functional branch of accounting standards board. However, currently, firms follow the international accounting standard (Linsley and Shrives 2006, 392). These companies are advised to adhere to the recommendations of the best practices as outlined in the United Kingdom’s code of governance. They are also encouraged to follow the turnbull report which shows direction on internal control (Linsley and Shrives 2006, 393). These make sure that the financial reports do not have fraud or misstatements. Moreover, the operational and financial assessment that came up in the legal status in late 2005 was changed into best practices standard rather than a compulsory standard (Linsley and Shrives 2006, 393). This was adapted to reduce the tension on the private sector on reporting. In as much as there are some issues faced in narrative reporting, many benefits come with narrative reports in the United Kingdom. First, narrative report results into improved business understanding, enhanced governance and entire board effectiveness (Abraham and Cox 2007, 230). This implies that a comprehensive narrative report has the ability to give the board a better image of the performance of the corporation besides fiscal aspects. The narrative report in addition, provides a different perspective based on the health and sustainability of the company (Abraham and Cox 2007, 230). Furthermore, narrative report gives the investors a clear understanding of the business. Also, it enhances the relationship that exists between the business and its stakeholders. Businesses and firms with effective narrative reports will offer the investors and stakeholders a better picture and understanding of the real things that drives the firm or the company (Abraham and Cox 2007, 230). This consequently allows for evaluating whether or not the strategies that are implemented are the most relevant. Narrative Reporting is also significant since it aligns with the strategies of announcement (Abraham and Cox 2007, 231). It achieves this by giving a framework which eases communication issues like changing the indices of social responsibility, volatile earnings, and change in governance. As a result of a detailed narrative reporting from within the company, the company can cautiously assess the way information is transferred to external users through narrative report (Abraham and Cox 2007, 231). Narrative reporting therefore ensures a better summary regarding the company to its users. It achieves this by outlining various aspects such as clarity, transparency and relevance. It brings out efficiency and effectiveness besides strengthening communication (Abraham and Cox 2007, 231). All these allow for easy assessment of corporate strategies of the company. Question 7: Explain the factors that might manipulate the quality of accounting information and explain how an analyst would adjust for questionable accounting quality Quality information is among the competitive advantages for a business. The quality of information given in the accounting system of information is essential to the prosperity of that system (Brammer and Pavelin 2008, 128). Several factors affect the quality of accounting information. These factors can be broadly categorized into stakeholders’ related factors, organizational factors and external factors (Brammer and Pavelin 2008, 128). Under the stakeholders’ related factors, we have the degree of commitment of the top management, employee relations, user focus, information supplier quality management and audit and reviews (Brammer and Pavelin 2008, 128). If the management of the group is not committed to its job as a manager, the quality of accounting information will be likely to be negatively affected. Poor management results into inconsistent and invalid accounting information (Brammer and Pavelin 2008, 129). If the data quality manager of a given company is incompetent, then the quality of accounting information stands a chance of being questionable. Appropriate and correct quality of accounting information demands focused management that are conscious of the goals, aims and objectives of the business (Brammer and Pavelin 2008, 129). The employee’s relations has an impact on the quality of accounting information obtained. A good working relationship between the employees in a firm improves the quality of accounting information of that company (Brammer and Pavelin 2008, 129). However if the relationship is not cordial and unprofessional, the quality of accounting information is at risk of being poor. This is because accurate and proper accounting requires a mind that is free from any form of tension (Brammer and Pavelin 2008, 129). The auditors for instance, should relate well with the top management team to allow for smooth processing of accounting information. The legislative factors include the training, the structure of the organization, and the culture of the organization, the performance evaluation rewards and teamwork (Brammer and Pavelin 2008, 130). The level of training considered by the organization affects the quality of accounting information. A company that recruits well trained personnel produces quality data compared to one employing less trained workforce and vice versa (Brammer and Pavelin 2008, 130). A company structured in a way that is easily manageable has high chances of producing quality accounting data than the one having long chains of management. The culture and beliefs of the company affects the data quality since a people’s way of living dictates how they work out things (Brammer and Pavelin 2008, 130). An organization that rewards its employees fairly through motivations boasts of quality products since reinforcements gives workers the drive to be competent. An effective channel of communication within a company is very important for quality information process (Brammer and Pavelin 2008, 130). A poor information flow affects the quality of accounting data. External factors such as noise within the organization affects concentration and consequently impacts on the quality of accounting information obtained quality, they can employ internal auditing, an independent consulting and objective assurance activity that is designed to improve and add value to business operations. Interior audit causes a logical and systematic strategy to evaluation and enhances the effectiveness of risk governance, control and management processes (Feng 2001). It achieves this by giving insight and recommendations focused on assessments and analyses of business processes and data. Question 8: Explain the agency theory rationale for the publication and regulation of financial statements, and in this context describe and critically evaluate the work of International Standards Board. Agency theory has been extensively made use of in the field and literature of accounting in explaining and predicting the engagement and performance of external auditors (Berger and Bonaccorsi di Patti2006, 1070). The agency theory, in addition, gives a significant theoretical framework for the learning of the purpose of the internal auditing (Berger and Bonaccorsi di Patti2006, 1070). In this sense, group theory not only assists in explaining and predicting the reality of internal audit, but also assists in explaining the functions and responsibilities given to these internal auditors by their respective companies (Berger and Bonaccorsi di Patti2006, 1071). In addition, bureau theory is responsible for predicting the manner in which the function of internal audit is likely to be impacted on by the changes in the company (Berger and Bonaccorsi di Patti2006, 1071). Above all, agency theory is a body that gives a foundation for rich research. This research is both beneficial to the internal auditing profession as well as the academic community (Berger and Bonaccorsi di Patti2006, 1071). The international accounting standards committee, presently known as international accounting standards board, is the organization that is accountable for providing international accounting standards (Barth Landsman and Lang 2008, 482). This body was founded in London as a unit of a private nature and is a product of an agreement between main professional associations (Barth Landsman and Lang 2008, 482). This organization has been able to take part in the development of standards both in the accounting profession as well as in the representatives of financial analysts, investors, business and academia. This body was developed in the public interest to set high quality, enforceable and understandable international standards of accounting (Barth Landsman and Lang 2008, 482). It deals with high quality, capable and transparent information in financial reporting and in financial statements. This helps the participants in many capital markets in the world as well as other users of information to appropriate economic decisions. The use of the international standard board also encourages the use and meticulous application of those standards (Barth Landsman and Lang 2008, 483). In addition, this body works closely and actively with the international standard setters to realize union of the international accounting standards as well as the international financial reporting standards to recognize high quality solutions (Barth Landsman and Lang 2008, 483). The international standard board is premeditated to be relevant to the general purpose monetary statements as well as other financial reporting of the entire profit oriented bodies. These unions include those that take part in industrial, commercial and financial activities whether structured in corporate or other structures (Barth Landsman and Lang 2008, 483). The international standard board is currently focused in partnership with other accounting related organizations to congregate standards and come up with one universally conventional set of biding global accounting standards (Barth Landsman and Lang 2008, 483). Reference list Abraham, S., & Cox, P. 2007, Analyzing the determinants of narrative risk information in UK FTSE 100 annual reports. The British Accounting Review, 39(3); 227-248. Barth, M. E., Landsman, W. R., & Lang, M. H. 2008, International accounting standards and accounting quality. Journal of accounting research, 46(3); 467-498. Berger, A. N., & Bonaccorsi di Patti, E, 2006, Capital structure and firm performance: A new approach to testing agency theory and an application to the banking industry. Journal of Banking & Finance, 30(4); 1065-1102. Brammer, S., & Pavelin, S. 2008, Factors influencing the quality of corporate environmental disclosure. Business Strategy and the Environment, 17(2); 120-136. Christensen, P. O., Demski, J. S., & Frimor, H. 2002, Accounting policies in agencies with moral hazard and renegotiation. Journal of Accounting Research, 40(4); 1071-1090. Feng, L. 2001, The Institutional Arrangements and the Quality of Accounting Information: A Case Study [J]. Accounting Research, 7, 001. Guthrie, J., Petty, R., Yongvanich, K., and Ricceri, F. 2004, Using content analysis as a research method to inquire into intellectual capital reporting. Journal of intellectual capital, 5(2); 282-293. Healy, P. M., & Palepu, K. G. 2007, Business Analysis and Valuation: Using Financial Statements. Huizinga, H., and Laeven, L. 2009, Accounting discretion of banks during a financial crisis. Centre for Economic Policy Research. Linsley, P. M., and Shrives, P. J. 2006, Risk reporting: A study of risk disclosures in the annual reports of UK companies. The British Accounting Review, 38(4); 387-404. Livingstone, L. 2009, Analyzing Financial Statements. The Portable MBA in Finance and Accounting, Fourth Edition, 19-37. Quaglia, L. 2007, The politics of financial services regulation and supervision reform in the European Union. European Journal of Political Research, 46(2); 269-290. Read More