Accounting Standards - Assignment Example

Name) (Instructor) (Institution) (Course code) (Date) Question 1 Introduction Accounting standards are a set of rules, principles and guidelines employed in financial accounting, which helps firms and corporate companies to prepare and presents their business assets, income, liabilities and expenses. GAAP consists of various groups of distinct standards (Godfrey and Chalmers, 2007, Pg. 89) The major goal of accounting standards is to institute recognition, measurement, analysis, presentation and the revelation needs pertaining financial transactions and the major events which are very essential in the financial statement of firms and companies. The financial statements present the public and the end-users with crucial information, as well as an in depth reflection of the company and organization’s cash flows, position and performance (Godfrey and Chalmers, 2007, Pg. 89) Various users of the financial statements include government agencies, employees, potential investors, suppliers and the shareholders. Account standards therefore give a basic framework for the presentation of financial statements in a fair and credible way, such that it presents the correct overview of the firm’s financial status. These accounting standards aid in the presentation in a homogenous and coherent way, so that the consumers globally are able to source the information and make informed decisions from them. Rules based standards versus Principles based US secretary Heary Paulson suggested that we must come of out mentality that ask if it is legal and adopt the principle that asks if it is right. The differences between the two standards are as discussed below Rules based accounting is basically involve a list of rules and principles that must be adhered to when preparing companies or organizations financial statements. These rules are obtained from a theoretical framework that give broad standards to be followed within the principles and also needs managerial and professional decision in relevance to specific events and transactions On the other hand, principle based accounting offer a theoretical framework for the accountants to comply with instead of a list of rules The principle method, the accountants by laying out the main goals of reporting in the subject section before showing the guidance giving the goals. As rules are inevitable, the principle based method does not intent to set particular rules or guidance for every step. If the accountant or the reader is in doubt, he/she is directed back to the principles (Godfrey and Chalmers, 2007, Pg. 89) Advantages and disadvantages Rules based accounting Advantages The rule boosts verifiability regulators and auditors and associated reduction in litigation. The rules can boost the precision with which the standard setters set their desires and improve comparability The set rules shrink prospects for earnings management through decisions, can lower the kind of imprecision that results in aggressive reporting decision by the managements Disadvantages This method is problematic as those who need to abide by the set rules are not at all time not certain of everything they need to look at. Those who try get around the set rules can apply legal strategies to try to do it. Another disadvantage is the rigid approach whereby any transaction should accounted in harmony with the rules despite the fact that the accounting is misleading. There is also an increased risk when the rules are not followed to the latter as it is difficult to defend one when it is broken. With this method it is very hard to compare various industries even the transactions are the same Principles based accounting Advantages Some of the benefits of the principle based include its broad guidelines which can be applied in several phenomena. These broad principles avoid the drawbacks linked with precise requirements that let contracts to be written particularly to influence their intent. It also permits the accountants to use professional decision while assessing the transaction element This method results in simpler standards as reported by Herz that it would results to standards of less than 12 pages and not over 100 pages long. The principle based standards also give accounting statements that precisely give the company’s actual performance Disadvantages Due to its lack of specific guidelines, principle based accounting could result in discrepancies in the use of standards across the organization. For instance, organizations are required to distinguish a liability and an expense for a dependent liability hat estimable and probable. Another disadvantage of this method is the lack of bright-light standards which lowers the consistency and comparability, a key precept of financial accounting Question 2 The rules based system originated from United States of America from intensive control of financial reporting. It went through a series of transformation that resulted in the establishment of more rules. The transformation motivated by the desire of comparability. US desire for the certainty in case of litigation against firms, organisations and auditors also let the development of their rules-based approach The United States GAAP grew into rules-based approach for the reason that reflects a ‘cookbook’ approach. Nevertheless, there is no explicit description of what cookbook approach indicates but it suggests it empowers the auditors and preparers of financial information of what they ought to do (Freepatentsonline.com, 2014) This GAAP came under fire because many stakeholders believed to be part of the contributing factors in many business failures and accounting scandals. This therefore resulted in believe that rules based approach is very involving and difficult to carry out and with many exclusions (Previts, Walton and Wolnizer, 2011, Pg.138) Should the believe that United States GAAP is purely rule-based and multifaceted are correct, then the it’s elements and aspects should lead to lower accounting reports when the new standards are put in place. On the contrary, principle-based approach is affirmed to have a more expert decision on financial information (Freepatentsonline.com, 2014) Additionally, as a result of large disapproval of the US rules based approach, the US Securities Exchange has proposed the implementation of principles-based approach in the accounting standards. The SEC has set standards that would be met by the firms, organisation and companies should the US adopt IFRS as they carry out a wider approach than the existing ones (Previts, Walton and Wolnizer, 2011, Pg.138) Question 3 The Securities and Exchange Commission carried out a research to find out what is required to change in order make the implementation of principles-based approach, an international standard. The research was to check whether the principles principle-based standards would implemented successfully. They analysed The Accounting for Conditional Asset Retirement Obligations, the FASB Interpretation No. 47. Following the analysis, they concluded that if the firms were to follow the principles set in the SFAS 143, they would be no need to amend the accounting practices because of FIN 47. However, some changes need to be made in order adopt the principles-based standards reporting in the United States. There were some concerns about the shift in paradigm towards the principles-based approach. Some of the raised issues include the opportunity for earnings management. There is the notion by the managers to have the motivation to influence the financial status. The change of the accounting standards to principles-based would not bring changes to this as shown in late 1990s to 2001 accounting failures from the increase in the equity-based pay which associated pay with the stock performance giving the motivation to falsely inflate the earnings (Epstein, Bragg, & Nach, 2009, Pg. 14).  What need to be changed in order for the successive implementation of principles-based accounting in the United States are the incentive structure and the enforcement mechanisms. This is loophole Enron found and took advantage of it. Therefore the key thing is first the change of the enforcement standards before the standards themselves (Epstein, Bragg, & Nach, 2009, Pg. 14).  Question 4 In order to meet the global harmonisation accounting standards, the International Accounting Standards Board encounters the problem of identifying a better standard of accounting between principles based and rules based that will lead better convergence. Traditionally the rules based accounting resulted in complex and detailed standards, which led to rather arbitrary rules that permitted firms to structure transactions in their preference, thus possibly aggravating the principle-agent complication between the owners and managers. The majority considers principle based standards will promote reporting the gives the correct position of a company. Instead of forming transactions to satisfy certain criteria, organisations should analyse the elements of their operations to establish the suitable accounting treatment and subsequent financial statement (Previts, Walton and Wolnizer, 2011, Pg.138) Additionally, principles-based accounting is considered to be offering increased protection for firms and companies. If the company is sued, they can defend themselves basing on their best alternative taken. Despite global regulators prefer principles-based standards, they are more concerned about the United States inclination towards lawsuit. Another worry of the International Accounting Standards Board is how to guarantee constant use of the principles-based standards globally. Even though principles-based standards show better economic performance, they make it difficult to compare firms and companies (Previts, Walton and Wolnizer, 2011, Pg.138) Recent corporate collapse Apart from Enron and World.com collapses in United States, there are many other corporate collapse of which some recovered while others did not. Some of those that did not recover include; Allied Crude Vegetable Oil Refining Corp (1963), Texaco (1987), Long-term Capital Management (1998), Pacific Gas and Electric Company (2001) Chiquita Brands Int (2001), Kmart (2002), Adelphia Communications Corporations (2002), Arthur Andersen (2002), Bayou Hedge Fund Group (2005), Refco (2005), Lehmann Brothers (2008), AIG (2008), Washington Mutual (2008) and Dynegy (2012) Due to defective accounting practices, it led to the collapse of the following companies; Long-Term Capital Management and Bayou Hedge Fund Group. The management was responsible for the most of the collapses. They either defrauded the public and manipulated the shares and embezzled the cash by wiring them to foreign or private accounts Other causes I am going to focus on the collapse of Adelphia Communications Corporations which occurred in the year 2002. The company grew from $300 to the extent that it applied for chapter 11 for bankruptcy due to debts amounting to $19 billon (Rezaee and Riley, 2009, Pg. 12). Its collapse is attributed to the following key reasons: a There was lack of transparency The Board of Directors consisted of Rigas’ family members together with his friends. Despite the board comprising of Elite B schools Wharton and Harvard, former CEOs and judge, there was no liberal members. Due to this, there was no internal conflict and an implicit collusion developed within the board to approve and exacerbate the frauds. The best illustration can be demonstrated by the signing off the ‘co-borrowing’ plan despite all the control the company had. An impartial, autonomous director would have stopped that from taking place b Unplanned Acquisitions The company underwent an extensive acquisition stage. It acquired three large firms within a month and later added another two Florida based firms in a very short period of time. These unplanned acquisitions by Adelphia Communications Corporations resulted in liquidity crunch making the company to heavily depend on leveraging too fund the deals c There was no long term plan According to John Rigas, he lacked adequate financial exposure. This is clearly evident in the way they planned and developed the company. With the illogical subscription tariffs for cable, no WACC estimation, personal spending, lack of capital spending, Adelphia Communications Corporations did what appeared to be suitable to tackle the short term challenges or gain instant headwind. Eventually this was intensively felt when Adelphia Communications Corporations decided on co-borrowing and tapping in the company’s account via its holding companies d Wall Street pressure John did not rob Adelphia for self-benefit. When the tax and interest payments rose, it attempted to influence the balance sheet to grow in share price and satisfy stakeholders’ expectations. To counter the situation, John retained a high share price which enabled the company get debts. This worsens the situation of the Adelphia Communications Corporations. The false reporting of profits and the inflationary accounts were meant to keep the company going till John could get the company out of the mess. John’s hopes did not see the light of the day e Complete Control of Stakes John was always motivated to keep control of the company during his entire time at the helm of the company. From the time the company got public, John’s family voting was 95 per cent up to when the disclosure came out which then stood at 84 per cent. Despite the issuances of class B shares, they held just 26 per cent of them and yet they still did not dilute the voting rights. This massive control over the company gave the family total independence on the running of the Adelphia Communications Corporations. This perhaps gave him the authority to carry out all his private spending through the company’s account Conclusion Due to the above stated reasons, it is undoubtedly that the Adelphia Communications Corporations Company was headed to bankruptcy. Due to lack of financial planning and sound audits in place to put the house in order, money laundering in Adelphia Communications Corporations Company reached an all-time low. Despite John’s effort to clear all the existing debts, he got the company into more debts. His personal luxuries of buying cars and a hockey team for personal use; he did more to harm the already dilapidating situation of the Adelphia Communications Corporations Company. It was just a time bomb waiting to blow as false reporting went overboard leading to the company’s stumble References Epstein, B. J., Bragg, S. M., & Nach, R. (2009). Wiley Gaap 2010: interpretation and application of generally accepted accounting principles. Hoboken, NJ, Wiley, p. 14. Freepatentsonline.com, (2014). Are principles-based standards effective in theUS?. [online] Available at: http://www.freepatentsonline.com/article/Journal-Academy-Business-Economics/172011777.html [Accessed 9 Oct. 2014]. Godfrey, J. and Chalmers, K. (2007). Globalisation of accounting standards. 1st ed. Cheltenham, UK: Edward Elgar, p.89. Previts, G., Walton, P. and Wolnizer, P. (2011). A global history of accounting, financial reporting and public policy. 1st ed. Bingley: Emerald, p.138. Rezaee, Z. and Riley, R. (2009). Financial statement fraud: prevention and detection. 2nd ed. New York: Hoboken, N.J. : Wiley, p.12. Ukessays.com, (2014). Principles Verse Rules Based Accounting Standard Debate Accounting Essay. [online] Available at: http://www.ukessays.com/essays/accounting/principles-verse-rules-based-accounting-standard-debate-accounting-essay.php [Accessed 9 Oct. 2014].     Read More