Managing Companys Reported Operating Results - Essay Example

Summary: Campbell Soup Company The case, Campbell Soup Company is an examination of the evolution of Campbells corporate culture. It outlined the organizations extremely traditionalist perspective on business operations, which spanned almost 100 years until some changes transpired during the 1990s, which demonstrated the easing of the strict and rigid corporate culture. Under the traditionalist perspective, as the case study noted, the growth in revenues and profits of Campbell Soup registered very modest growth. The reform on policies started when the company borrowed capital from the debt market during the 1980s. From this period, Campbell diversified its products and posted billion dollars sale but small profits. The most important development, however, was due to its borrowings from investors, the company gradually became subject to the decision and pressures of stockholders. The most important of which include the managements protracted legal battles with investors. This dimension to Campbell’s existence has resulted to the adoption of management teams that were desperate to improve Campbell’s positive net margins because it affects the stock price. This the reason why it has pulled all the stops in order to generate the positive earnings that Wall Street demands to the point that illegitimate policies were adopted. Cases in point were the improper accounting, trade loading, among other policies. 1. Identify legitimate business practices that corporate executives can use for the primary purpose of manipulating or “managing” their company’s reported operating results. Are such practices ethical? Defend your answer. Examples of legitimate business practices that corporate executives can use in order to manipulate their organization’s operating results include: trade loading or the use of excessive price concessions in order for consumers to buy more products thereby propping up the reported revenues or profits for a specific period; and, converting given period-ending discounts as selling, general and administrative expenses instead of treating them as reductions of gross revenues. Another legitimate gimmick that organizations could legitimately use to smooth out its earnings and manipulate its operation reports is by putting excessive reserves on its balance sheet (i.e. for bad debts or defective merchandise) in one quarter, in effect, lowering earnings below what they otherwise would have been, and then reversing the process in another quarter, which would result to the conversion of some of the excess reserves into profit at a time when the company wanted to show a surge in earnings. The legality of the above practices does not immediately translate into ethical behavior. For instance, they violate the standards and rules of transparency, which requires documents to be accurate and verifiable. The deliberate manipulation and aim to deceive for the purpose of presenting an image that is not in actuality makes the processes, however legitimate, immoral, the primary factor why they can be considered unethical. 2. Suppose that a company uses one or more of the practices that you identified in responding to the previous question. What implications, if any, do those practices have for the company’s independent auditors? As with the case of Campbell Soup, independent auditors could be dragged with the company’s corporate executives as a defendant in the event of a class action suit once the manipulations were proved to be illegal. However, the independent auditors cannot entirely be made party to the crime since there are instances when they are not able to identify manipulations. In the examination of Judge Irenas, for instance, he pointed to the fact that the auditors could not have considered disproportionately heavy sales as irregular, citing large, period ending sales as tradition trend in Campbell’s operating results. The point being made here is that corporate manipulations of its books cannot necessarily be identified by auditors. They are not required to know all the transactions that transpire in the client company and that they examine accounting records on a sampling basis. Such method is necessary because the cost of auditing all of a company’s records would be prohibitive. 3. What auditing standards, if any requires auditors to determine whether their clients have properly classified key amounts in their periodic income statements? Identify three methods that audit clients can use to put a favorable “spin” on their reported operating results without changing the “bottom line” or net income. In the area of auditing standards, materiality is the criterion for establishing the importance of a potential misstatement in audited financial statements. This criterion requires the auditors to determine whether amounts – its estimates and allocations as per the management’s judgment – in the periodic income statements are not misstated. Some of the methods that audit clients can user to put a favorable spin on their operating results without changing the net income are: the manipulation of net income via depreciation (artificially depressing income in favorable period, while in lean years too little or nothing is written off); misrepresenting operating results; and, through the change in accounting method (i.e. from cash to accrual). 4. What audit procedures might have resulted in the discovery of the “shipping to the yard” and “guaranteed sales” schemes allegedly used by Campbell? The audit procedures that could best unmask shipping to the yard and guaranteed sales include a comprehensive auditing approach that is characterized by the analysis of financial data in relationship to the operational data, such as production capacity or purchased supplies, as well as industry information. In addition, the auditor should have considered fraud, from the very outset and determine all elements that make fraud likely such as inflated revenue, operational results, executive compensation, among other pressures to meet earning targets. The audit team must also have considered the existence of significant, complex or convoluted transactions as well as significant changes in financial conditions. Finally, the audit procedures should not be those that are predictable because it would have reduced the opportunities for the audit client to cover or perpetuate a fraud. 5. After reviewing PwC’s audit work papers, Judge Irenas ruled that there was insufficient evidence to support a strong inference of scienter or “reckless” conduct on the part of the audit firm. Do you believe that PwC would have been guilty of “recklessness”? It must be underscored that Judge Irenas ruling was based mainly on the lack of sufficient evidence that would incriminate PwC. It could have been the fault of the plaintiff because they failed to present what was required. Here, the most important element to be considered is the long relationship between Campbell Soup and PwC. While this relationship was punctuated by a token investigation and the fact that PwC raised the issue regarding trade discounts with the client, there remains the fact that PwC has consistently used the same auditing approach in its whole tenure as the audit firm for Campbell Soup. With this in mind, PwC has allowed its client to circumvent their procedures. I think that this constitutes reckless if not knowingly aiding Campbell Soup to perpetuate its unethical practices. In addition, there has been no concrete actions to check anomalous practices besides “the raising of the issue” and a token investigation. Through PwC’s long period of auditing relationship with Campbell soup, it has not found any anomaly in its financial reports and, supposing it did, the actions taken were not sufficient to satisfy the auditing standards of ordinary care. 6. Identify the parties affected by the PSLRA. Briefly explain how the federal statute affects each of those parties. The PSLRA amended the 1934 Securities Act and it affected several parties: corporate executives, independent auditors and plaintiffs associated with financial statements that are filed under the 1934 statute. The PSLRA modified the former joint and several liability frameworks in an attempt to eliminate perceived unfairness. This affected corporate executive and independent auditors in the sense that it introduced a new proportionate liability regimen characterized by the retention of joint and several liability for the defendants with actual knowledge on violations as per the 1944 Act, but adopts a modified liability scheme for defendants found to be les culpable (e.g. independent auditors). Finally, the amendment also affected plaintiffs because PSLRA made it difficult to assert what were perceived to be “strike suits”, which allege securities that lacked merit. Read More