The Tendency to Adopting Creative Accounting - Assignment Example

ADVANCED FINANCIAL ACCOUNTING ESSAY: “HIH INSURANCE CASE STUDY” Prepared by (Student’s Name) Professor’s Name Course Name Institution + City Date of Submission Advanced Financial Accounting Essay: “HIH Insurance Case Study” Question No. 1 Fairly noted, it is argued that companies do not consider the significance of adopting creative form of accounting in the course of normal operations of the firm rather than when they face immense levels of challenges. Thus, the move to assume the accounting practices by these firms is evident. In itself, creative accounting allows for accounting professionals to adopt accounting methodologies which are conversant with the results desired by preparers. Creative accounting is opportunistic in nature meaning that they are ex post thus are tailored to expound and predict on certain “propped-up” manners which are expected to happen in the near future of a company’s normal operations. In addition to this, creative accounting is tailored to allow for opportunistic actions to be assumed in the case that there are contractual agreements which were already put in place (Deegan 2010, 125). It is worth noting companies would, thus, not seek the tendency of adopting creative accounting until difficulties are detected given the fact that under the arising difficulties they are forced to adopt accounting methodologies which will catapult their sustainability chances. In the course of battling with the chances of its survival, hence the going-concern, they adopt different stages of sustainability first hand. In that case, these firms will have to report their financial performance to the different stakeholders concerned. In this manner, their confidence level is assured and the survival of their operations is guaranteed. In times of difficulties, such as the one experienced by HIH Insurance company in which it is faced with the challenge of misrepresenting its financial reports hence financial performance, companies tend to turn into creative accounting given the fact that the methodology allows for protection of self-interest. More to say, it is fair to postulate that the self-interest of the different stakeholders within the firm is challenged whenever it is deduced that financial reports have been done in an unethical manner. Thus, managers whose contractual arrangements are determined by such plans as “the bonus hypothesis plans” embark on opting for accounting methodologies which will transform anticipated future earnings into the present. Notably, the sole objective of any given business is to maximize the wealth of the shareholder while at the same time minimizing losses. In the course of difficulties, creative accounting is embraced apparently given the fact that it limits compromise levels of shareholder’s wealth by the unfortunate events. In the course of difficulties, it is assumed that companies are facing the threat of immense levels of losses which is subsequently contrary to the main objective of the firm. Like in the case of HIH Insurance Company, it is evidently clear to note that the management, in conjunction with the board, had agreed to undervalue the true and fair worth of the Company’s losses in the financial period reports ending 1998 and thus, protecting the existing shareholders from great levels of losses by the public domain. In the course of normal operations, firms operate in the absence of both loyalties and morality of the different stakeholders. However, this case is altered in the times of difficulties so that the aforementioned two attributes are incorporated in order to avoid possible chaos and loss of operations in that matter (Deegan 2010, 125). It should be noted that the relationship which exists between the manager and shareholder is that of the principal-agent relationship hence the managers as the agents are expected to be loyal to the owners of the companies irrespective of their involvement in the operations of the firm altogether. Question No 2: Does unexpected corporate failure suggest limitations in the roles of auditors and regulators? Explain your answer? It is fairly noted that most firms incorporate their different departments to each other in order to meet the key objective of their operations, which is, to maximize immediate wealth as well as minimize losses. Accounting and auditing department is no exception to this fundamental objective. This means that before any judgments are made by each of the departments, it is fair that the matter be raised beforehand in the presence of the managers as well as the board in that matter. This phenomenon is attributable to both internal and external forms of services. For instance, in the case of HIH Insurance Company it is attributed to the independent external auditor: Mr. Davies. It should be noted that the fundamental objective of any given auditor is to provide the financial report analysis services by considering matters concerned with both truth and fairness. It should also be noted that irrespective of whether services are internal or external, auditors are expected to work closely with the management in order to come up with solutions in case of difficulties. Thus, the roles of auditors are never limited in the case of successes of a company but later changes whenever failure is noted. Notwithstanding, it is safe to indicate that the relationship between the external auditor and the firm assumes the agency relationship which stipulates that the agreed arrangement between the agent and principal is for the agent to performs the duty or service on the behalf of the principal. Thus, the significant process of decision-making decree is delegated to the auditor as an agent. However, this does not overrule the fundamental facet that the two parties should work together lest arising of the agent problem. This arises whenever it is deduced that the key interests of the principal are overlooked as agents execute decisions for their own interests. Notably, auditors should provide prescriptive form of services to their principals. This means that they are entitled to analyze the different scenarios which may arise out of their ignorance and costs the firm more damage than good. Thus, they should be allowed to perform their duties independently and without interference from either the management or any other third party given the fact that they are purported to be acting on the very best interest of the firm at hand. Accounting theory allows prescriptive approach whenever those concerned are allowed to adopt accounting policies and standards which are conversant and thus favorable with the immediate operations of the firm. With respect to the managerial approach, the adoption of specific forms of accounting policies and standards are meant to expound on the manner in which entities will react to the different demands put forth by numerous stakeholders. Thus, it is figured out that the significance of these stakeholders cannot be taken for granted hence the management will transpire to assume those actions which will catapult positive relationships with stakeholders (Deegan 2010, 125). Well noted, a firm which confines the roles of the auditors for their self-gain are deemed to fail since evaluative-independence is considered to be the most fundamental attribute offered to auditors as a whole. Question No.3 Consider the problems of creative accounting referred to in the article. To what extent can normative accounting theories offer solutions to these problems? In itself, creative accounting is the adoption of accounting policies which are conversant with the preparer’s premeditated outcome. There are several problems, within the case study article, which have been attributed to this form of accounting. First, HIH Insurance had utilized a distinctive list of “one-off items” in order to reduce the size of its losses by $157 million. This means that the firm had assumed book reserves which were contrary to the provided tolerable- limits allowed by auditors and actuaries in that matter. Second, in order to protect the image of the Company’s operations the firm’s contractual insurer had taken more time to inhibit the public understand the inflated profits of FIA that it had purchased in 1998. Third, HIH had embarked on booking more of its payment amount in form of goodwill in the course of acquiring FAI by $300 million. Normative accounting methodology allows for one to try to find out appropriate form of guidance needed in choosing those accounting procedures and policies which are considered effective and efficient in that matter. Thus, it advocates for prescribing the logic actions which should be embraced and performed. Normative accounting is fairly postulated as an alternative to historic cost concept of accounting. Concerning the aforementioned problems, attributed to creative accounting, it is deduced that normative accounting can provide different effective solutions. First, HIH Insurance Company could have based its accounting procedures on current costs (Deegan 2010, 125). In that manner, the unethical behavior illustrated by its management to reduce losses by almost $ 157 million did not have resulted into a major financial hitch on the part of the stakeholders as a whole. Second, it is deduced that the Company could have deployed its accounting procedure on the set- selling price of underlying assets. This is effectively conducted by altering the existing “index of changes” in the general price stipulations. This solution could have fairly saved the Company from over-booking goodwill payments in the course of acquiring FIA enterprise. The decision by the firm to use goodwill as the immediate difference between the agreeable purchase price of net tangible assets and the exact price paid for the enterprise was completely overboard given the fact that the figure indicated a larger percentage attributed to goodwill than the current prices offered to the purchase of the tangible assets. Another form of solution which has been offered, as part of normative accounting, is the adoption of the deprival value concept. This concept allows for acquisition values of assets to be evaluated on the immediate value expected to be enjoyed by the owner. This is highly regards the purchase price which was paid for the acquisition of the FIA. The valuations should have assumed a proposition which allowed fair “value to the owner” concept given the fact that the “owner” had experienced immense levels of losses in the preceding financial periods. Reference List Deegan Craig, 2010, Australian Financial Accounting, 6th Ed, McGraw-Hill, Australia Read More