Letter from Prison - Stephen Richards - Case Study Example

Letter from Prison [Name] [Institution] Part 1 1. Seriousness of Stephen Richards’ Actions Stephen Richards actions were future- oriented and did not emphasize mostly on things like profit gains which are given by analysts. Most people including investors and customers consider the profit gains to judge the company’s performance (Biddle & Lindahl, 1982). According to Richards, this view is not good enough to judge the company’s performance. His actions concentrate on seriousness of adoption of policies that would act similarly to foundations for the company’s future. No, the adoption of accounting flexibility won’t change my answer. This is because some policies which Richards advocates for may take longer while others are short-term. Lack of cooperation by the company’s management is another barrier (Dechow, Sloan & Sweeney, 1995). For instance the board emphasizes on operational aspects rather than strategies and directions that could propel the company to great heights (Richards, 2008). Now that non-performance was not acceptable in Computer Associates, Richards had to take minimal risks to ensure the profits are either increased or are maintained. Though some risks could have high rewards, he feared trying them to ensure his job is secure. 2. Gray areas of Accounting I agree with Richards that it’s difficult to operate in the “gray areas” where one follows the accounting professional rules and principles. This is taught as part of ethics to accountants. One is not supposed to give room to interferences by external forces but as a human being, an accountant may be tempted to stop acting professionally. Sometimes managers may intervene and urge the accountant to twist the financial position of the company just to avoid tarnishing the firm’s image in the society (Bushee, 1998). If I were in Richards’s position, I would refrain from breaking my professional dignity by reminding the manager that I am committed to complying with my professional duties. This way the manager will find another way of tampering with the financial statements, though this could also be risky to my carrier as I might end up losing my job. In deciding on what to do I would have the options of resigning or suing the firm’s management in a court of law as this is against the law (Richards, 2008). 3. Step Back and Management’s Incentives and choices The management incentives that are adopted by Computer Associate are one, pressure exertion on employees; Richards explains that he used to pressurize his group to work harder and faster (Richards, 2008). This incites the employees to increase productivity as it is mostly accompanied by supervision although it creates a negative mentality amongst them and they can’t work hard when supervision is minimal. Non-performance is one thing that is serious in Computer Associates and can easily lead to loss of jobs. This again incites the employees to be more productive and avoid the fire (Chalmers, 1999). This is a good method of ensuring hard work even when there is minimal supervision. Compensation of executives especially the senior executive is the other incentive adopted by Computer Associates. This incites the leaders to ensure that work is smooth and also encourages investors because of the gains they are likely to get from investing. Option compensation is the other incentive where the firm’s workers are compensated using stock options (Beaver, 1968). This encourages them to put more effort and convert to share holders in the company. The company’s choices include one; the management chose commanding as a way of communicating with employees. Richards (2008) used to be pressurized by the senior managers and he would in turn be forced to pressurize his team members just to complete what the manager needed of them. Richards chose to engage in “gray areas” where he broke his principles as a profession due to pressure from the managers. Research has identified Anglo-American model and Multi-stakeholder instruments for governing the corporations. Under the Anglo-American model the emphasis is on the company’s shareholders interests thus workers and clients are not considered. In Multi-associated clients, leaders as well as supplier interests are considered. Computer Associates adopted the Anglo-American model and it is not an effective model for the company to accommodate the outcomes of financial accounting. 4. GAAP standards allowing Recognition of the Licensing Contract Value as Revenue There is increased concern over revenue recognition of software’s licensing contract especially under the current GAAP which departs from the former GAAP. The GAAP that directly apply to revenue recognition of licensing contract as revenue include SFAS no.86 which is an expenditure method. This is a GAAP method followed by Computer Associates although sometimes perceived as intuitive to the idea that an asset is complete when it becomes useable. According to this latter concept, the software cannot give any revenue until it is shipped. At the time of making the contract, there is recognition of the Statement of Position no.97-2 SRRR of a maintenance and combined software. This recognition is achieved via the use of determinable as well as particular amounts so as to value the part recognized (Beaver, Lambert & Morse, 1980). Licensing of software directly is a major part of revenues for those developing them and their recognition according to the current GAAP is done when the license is shipped and is not postponed to later time. The culture at Computer Associates as presented in the letter from prison is similar to the presentation of these GAAP standards (Richards, 2008). In recognizing the elements of revenue, conflict arises due to the business goal of the sale that drives recognition. The other issue arises from the changes in the practices of reporting that contrasts the recognition process. There are arguments that business goal should be a principle to drive revenue recognition from an agreement of license. One part of the argument is that the license agreement should be perceived as a sequence of occurences over time while free from other services. On the other hand, the user-licensee is utilizing the developer-licensor asset. The second part of the argument is that the liability level of delivery is understated by full recognition of the contract value when the license is delivered. Some up-font fee which is not refundable ought to be recognised as revenue at the time subscription is being made. The last GAAP standard related to recognition of contract revenue is the quasi-Off type of Accounting. This accounting method exposes the companies to a phenomenon that affects the end of the quarterly called Crunch. This is a case where developers sign contracts in a rush at the termination of a period so as to enhance sales value recognition. Computer Associates use the AICPA’s SOP 97-2 provision as a residue way of recognising revenue. This accounting treatment described above further contributed to the culture at Computer Associates as it is evident from the letter that the firm was more into monitoring the processes that were adding revenue but was less concerned with the non revenue areas. 5. Meeting the Analyst Estimates according to the Inflated Record Revenue and EPS Any given organization should meet the analyst’s estimates in accordance with the Inflated Record Revenue as well as the EPS (Duke & Hunt, 1990). As such, Computer Associates is not exceptional and should meet the estimates. There are various reasons why meeting the estimates is important. With the current stock market, most business leaders live from one doomsday to the other of quarterly accounts. Meeting analyst’s estimates helps the organization to give the true as well as fair reflection of the financial position of the company. This is so because of the increased competition in the environment that companies like Computer Associates operates. The inflated records help the company to display the financial statements and accounts of the company. Meeting the analyst’s estimates is important for Computer Associates to avoid corporate fraud issues similar to the one that resulted from addiction to the morbid stock market for their quarterly reports. The inflated record revenue of the company should help it evade securities frauds as well as obstruction of justice (Christenson, 1983; Christie, 1990). This assessment is noble for Computer Associates in order to ensure their financial statements are healthy. Being in line with the analyst’s estimates would also protect the sales of the company to fall short and continuation of booking new sales. The estimates are also important in structuring the hypothetical transactions for looking for financing thereby retaining the company’s off balance sheet (Jones, 1991). The image of the company is also upheld by meeting the analyst’s estimates as well as profit projections remain stable. Transparency is also achieved by meeting the analyst’s estimates and thus preventing corporate scandals. 5. Impact of Accounting Management/Manipulation on Stock Prices According to Grant (1980), manipulation in the market means attempting to deliberately interrupt the free as well as the fair working of the market and formation of artificial appearance with regard to the price (Basu, 2004). As such, accounting manipulation has an effect on the prices of stocks. Referring to the hypothesis of no-effects, we find that there are no stock prices that are related to voluntary transformations in procedures of accounting unless they possess any impacts on cash flow. The no-effect is based on zero contracting costs, EMH and CAMP. The other hypothesis is mechanistic that underlies mostly the prescriptions of accounting. It presents as true a mechanical association between changes in stock price and accounting variations. Mechanistic hypothesis dictates that the stock market can be misguided systematically by managers through manipulation of the earning numbers via changing accounts. On the other hand, the no-effect hypothesis suggests that market is capable of seeing via the earning number (Watts & Zimmerman, 1986). The mechanistics and functional fixation are similar in many aspects but they are different. The difference occurs in that the mechanistic is concerned with aggregate conduct whereas functional fixation is concerned with individual investor’s behavior (Watts & Zimmerman, 1986). Composition’s fallacy claims that the efficiency of markets can be achieved even when the individual investor is behaving in manner suggesting otherwise. The above evidence is suggestive of Richards’ actions that he accelerated revenue that influenced trading of stock conduct. Part 2 Impact of Accounting Standards (either Individually or the Introduction of International Accounting Standards) on Stock Prices Accounting standards are principles which are set-up by the International Accounting Standards Board which is the recognized internationally body for setting up of accounting methods and principles, the principles have the following effects on stock prices of listed companies and are aimed for use in the world’s capital markets (Greuning & Koen, 2001). The new accounting principles permit measurement of investments, assets, and even securities by their fair value (Ball & Brown, 1968). They can also be recorded on the income statement; this means that depreciation should not be recorded on assets which are measured in their fair value. However, their allowances may be recorded under some circumstances but once recorded; they cannot be reversed or treated. This means that no changes are experienced on the company’s profits thus the company’s stock prices are likely to be maintained or increased (Sloan, 1996; Hirshleifer, Hou, Teoh & Zhang, 2004; Taffler, Lu & Kausar, 2004). Fair value should be totaled and the assets shortage or its overage explained as profit or loss on the fair value. Big changes on the an assets fair value in a given period is likely to cause big changes on the operating profit to impresses investors as they tend to think the assets of the company and its profits are fluctuating (Blake & Lunt, 2001). Debt reorganization is only acknowledged if the creditor agrees. Thus listed companies are restricted from earning control through debt reorganization with irrelevant companies. The debtor is also regulated in that he ought to present the evidence of fair values through debt reorganization. The debtor does this through financial statements and this rule applies to listed companies which apply correlative transaction as a profit control method but in case there is a huge income tax rates, balance with the related company’s earnings control is still possible in debt reorganizations. This way the company’s earnings can be controlled (Blake & Lunt, 2001). Investors have gained confidence due to the regulations that protects them and maintains the confidence. This has led to free capital movement thereby stepping up competition between companies in the region for financial resources in the capital market. This is because they have equal opportunities even in the stock market as long as they are from the region (Peng & Ming, 2006). A parent’s companies income statements should include its domestic subsidiaries and its foreign subsidiaries unless some control have been lost or for temporary intentions (Coase, 1937; Deakin, 1979; DeAngelo, 1988; and Feyerabend, 1993). The principles that are introduced come up with new ways of accounting methods e.g. before the introduction, the T-balance sheet was used but after the introduction there is another outline of a balance sheet. New regulations have also been introduced about what should be entered in different accounting records e.g. entering the fair value in the income statement was not done before (Godfrey & Chalmers, 2007). Revised methods of processing intangible assets: development costs are now entered as capital expenditure as long as it satisfies required conditions. Such costs are entered like current profit or current loss. This leads to decrease in current income thus the standards can cause higher income during early stages and lower in future because of delay in time when accounting for expenditure as current loss (Beaver, Clarke & Wright, 1979). The accounting standards do not lead to changes in stock prices because processing methods changes the profit in that period but no changes will be experienced in the real cash flow. This means the new standards are more likely to change the stock price of the company (Dhaliwal, 1980). References Ball, R. J, & Brown, P. (1968). An empirical evaluation of accounting income numbers. Journal of Accounting Research, 6 (Autumn): 159-178. Basu, S. (2004). What do we learn from two new accounting-based stock market anomalies? Journal of Accounting and Economics, 38: 333-348. Beaver, W. H. (1968). The information content of annual earnings announcements .Empirical Research in Accounting: Selected Studies. Journal of Accounting Research, 6: 67-92. Beaver, W. H., Clarke, R., & Wright, W. (1979). The association between unsystematic security returns and the magnitude of earnings forecast errors. Journal of Accounting Research, 17: 316: 340. Beaver, W. H., Lambert, R., & Morse, D. (1980). The information content of security prices. Journal of Accounting and Economics, 2: 3-28. Biddle, G. C., & Lindahl, F. W. (1982). Stock price reactions to LIFO adoptions: the association between excess returns and LIFO tax savings. Journal of Accounting Research, 20 (Autumn): 551-588. Blake, J., & Lunt, H. (2001). Accounting standards. London: Pearson Education. Bushee, B. (1998). The influence of institutional investors on myopic R & D investment behavior. The Accounting Review, 73 (3): 305-333. Chalmers, A. F. (1999). What is This Thing called Science? 3rd Edition. Indianapolis/Cambridge: Hackett Publishing Company, Inc. Christenson, C. (1983). The methodology of positive accounting. Accounting Review (January): 1- 22. Christie, A. A. (1990). Aggregation of test statistics: an evaluation of the evidence on contracting and size hypotheses. Journal of Accounting & Economics, 12: 15-36. Coase, R. H. (1937). The nature of the firm. Economica: 386-405. Deakin, E. B. (1979). An analysis of differences between non-major oil firms using successful efforts and full cost methods. The Accounting Review, 54: 722-734. DeAngelo, L. E. (1986). Accounting numbers as market valuation substitutes: A study of management buyouts of public shareholders. The Accounting Review, 61: 400-420. DeAngelo, L. E. (1988). Managerial competition, information costs, and corporate governance: the use of accounting performance measures in proxy contests. Journal of Accounting and Economics, 10: 3-36. Dechow, P. M., & Sloan, R. G. (1991). Executive incentives and the horizon problem. Journal of Accounting & Economics, 14: 51-89. Dechow, P. M., Sloan, R. G., & Sweeney, A. P. (1995). Detecting earnings management. The Accounting Review, 70: 193-225. Dhaliwal, D. S. (1980). The effect of the firm’s capital structure on the choice of accounting methods. The Accounting Review, 55: 78-84. Duke, J. C., & Hunt, H. G. (1990). An empirical examination of debt covenant restrictions and accounting-related debt proxies. Journal of Accounting and Economics, 12: 45-63. Feyerabend, P. (1993). Against Method. New York: Verso. Foster, G. (1977). Quarterly accounting data: time-series properties and predictive-ability results. Accounting Review, 52: 1-21. Godfrey, J., & Chalmers, K. (2007). Globalisation of accounting standards. London: Edward Elgar Publishing. Grant, E. B. (1980). Market implications of differential amounts of interim information. Journal of Accounting Research, 18: 255-268. Greuning, H., & Koen, M. (2001). International accounting standards: a practical guide. Newyork: World Bank Publications. Jones, J. J. (1991). Earnings management during import relief investigations. Journal of Accounting Research, 29: 193-228. Peng, X., & Ming, W. (2006). The Main Change of New Enterprise's Accounting Standards and Impact on Enterprise. Beijing: Finance and Accountig. Richards, S. (2008). A letter from prison. Read More