Financial Decision Making 8 questions 4 papers

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec1.… 97/150

NEXTNEXT

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec1.… 98/150

Summary and Resources

Chapter Summary

The purpose of the statement of cash flows is to determine how cash flowed into and out of the company during a certain period of �me. The statement can be in either direct or indirect format; the indirect format is more commonly used because it reveals less financial informa�on to financial report readers outside the company. The direct method requires companies to reveal addi�onal informa�on about how cash is used, such as amounts for cash received from customers or cash paid out to vendors. The statement has three sec�ons: opera�ng ac�vi�es, inves�ng ac�vi�es, and financing ac�vi�es. The Opera�ng Ac�vi�es sec�on: This sec�on summarizes the inflows and ou�lows of cash from opera�ng ac�vi�es of the company, such as cash received from customers based on changes to the value of the accounts receivable account or cash paid out to vendors based on changes in value to the accounts payable account. The Inves�ng Ac�vi�es sec�on: This sec�on summarizes the ou�lows of cash used for investments to grow the business or the inflows of cash received from selling major assets. The Financing Ac�vi�es sec�on: This sec�on summarizes financing ac�vi�es, such as cash inflows from taking on new debt or issuing new stock. It also summarizes ou�lows for the paydown of outstanding debt or the buyback of stock from investors. The bo�om line of this statement indicates whether cash on hand increased or decreased from the company's opera�ng, inves�ng, and financing ac�vi�es during the accoun�ng period being reported. We demonstrated how to do a quick analysis of the statement of cash flows. Reading the notes to the financial statements and the management's discussion and analysis can provide addi�onal informa�on about the company's cash inflows and ou�lows.

Takeaways for Chapter 4

Be sure to review all three sec�ons of the statement of cash flows to determine how cash flows into and out of the business. Don't just look at the bo�om line or focus solely on opera�ng ac�vi�es. If opera�ng ac�vi�es result in a net cash ou�low, there is cause for concern because it means the company's opera�ons are not genera�ng enough cash to operate the business. Managers should be aware of how cash is being used to grow the business or if cash was raised by selling off parts of the business. Managers must be aware if the company is taking on major new debt or selling addi�onal shares of the company to investors. Both ac�ons will impact the value of the company's shares. This can be especially important for managers whose compensa�on is par�ally based on stock incen�ves.

Discussion Ques�ons

1. Why is it important to analyze the statement of cash flows? 2. What problems would you look for if the net cash flows from opera�ng ac�vi�es were nega�ve? 3. What ques�ons would you seek to answer if the company's net cash from financing exceeded the net cash from opera�ons? 4. What ques�ons would you seek to answer if the net change in cash reduced cash holdings? 5. What can you learn from the use of cash in the Inves�ng Ac�vi�es sec�on?

Further Reading/Resources

Broome, O. W. (2004, March/April). Statement of cash flows: Time for change! Financial Analysts Journal, 60(2), pp. 16–22.

Robero, S., & Berenson, A. (2002, June 26). WorldCom says it hid expenses, infla�ng cash flow $3.8 billion. New York Times. Retrieved from h�p://www.ny�mes.com/2002/06/26/business/worldcom-says-it-hid-expenses-infla�ng-cash-flow-3.8-billion.html (h�p://www.ny�mes.com/2002/06/26/business/worldcom-says-it-hid-expenses-infla�ng-cash-flow-3.8-billion.html)

Siegel, M. A. (2006, March). Accoun�ng shenanigans on the cash flow statement. The CPA Journal, 76(3), pp. 38–43.

Key Terms

Click on each key term to see the defini�on.

disposi�ons (h�p://content.thuzelearning.com/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/c

Sales of a por�on of the assets of a company, such as the sale of a division or a factory.

financing ac�vi�es (h�p://content.thuzelearning.com/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/c

Cash that flowed into or out of the business from transac�ons involving debt or stock.

inves�ng ac�vi�es (h�p://content.thuzelearning.com/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/c

Cash that flowed into or out of the business from transac�ons involving the purchase or sale of long-term assets.

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec1.… 99/150

opera�ng ac�vi�es (h�p://content.thuzelearning.com/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/c

Cash that flowed into or out of the business from transac�ons involving the day-to-day opera�ons of the business.

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec… 100/150

5 Evalua�ng the Quality of Financial Reports

Energy company Enron's bankruptcy and illegal financial repor�ng were primary events that led to stricter government oversight.

Bre� Coomer/Associated Press

© amnarj2006/iStock/Thinkstock

Learning Objec�ves

A�er reading this chapter, you should be able to:

1. Understand the role of regulatory oversight. 2. Recognize the elements of quality financial repor�ng. 3. List key differences in how informa�on is reported in the United States versus requirements of interna�onal repor�ng

agencies. 4. Explain the role of the auditor. 5. Iden�fy accoun�ng tricks.

Introduc�on Enron, a former Texas energy company, is known today primarily for its spectacular demise. But for years, the company was a respected presence in Houston: It employed 20,000 people and was one of the world's major electricity, natural gas, communica�ons, and pulp and paper companies, with revenues of over $100 billion reported in 2000.

By the �me the company declared bankruptcy in 2001, however, it was best known for forever changing the public trust in a company's financial reports. Enron's massive financial report manipula�on, revealed when the company filed for bankruptcy protec�on with $38 billion in outstanding debts, opened the eyes of the public to the games companies can play with their financial report numbers.

In fact, the former mul�-billion-dollar company used almost every trick in the book to hide its losses from investors. This included keeping some of the biggest losses off its financial statements completely by using off-the-balance-sheet financing of its foreign projects.

The Enron bankruptcy and revela�ons of its unethical and illegal financial repor�ng sent shock waves throughout the country and the world. The U.S. Jus�ce Department ini�ated a criminal inves�ga�on, and execu�ves from Enron and Enron's audi�ng firm, Arthur Anderson, were indicted on obstruc�on of jus�ce charges rela�ng to the shredding of documents and on conspiracy to commit wire and securi�es fraud. Some execu�ves were convicted and served prison sentences. In 2002, Arthur Anderson voluntarily surrendered its license to prac�ce as a Cer�fied Public Accountant.

A new era of financial report oversight started with the passage of the Sarbanes-Oxley Act in 2002. Since the passage of Sarbanes-Oxley, top execu�ves must cer�fy the accuracy of their company's financial informa�on. Penal�es for fraudulent financial ac�vity are much more severe. The law also increased the independence of outside auditors and increased the responsibili�es of corporate boards of directors by giving them a greater oversight role in financial repor�ng. All managers in today's business world must be aware of the regula�ons and the agencies that enforce these regula�ons (Orin, 2008; Prawi�, 2012).

In this chapter, we review the checks and balances that are in place for financial repor�ng. First we examine the regulators who maintain oversight of the financial reports filed by publicly traded companies in the United States and abroad. We also explore the elements of a properly prepared financial report and review some key differences between U.S. GAAP rules and interna�onal repor�ng rules. We probe the role of the auditor, who ensures that financial reports accurately represent a company's financial posi�on. Finally, we examine some of the "crea�ve" ways in which a firm might prepare its reports to hide its financial problems.

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec… 101/150

5.1 Regulatory Oversight We introduced the concept of generally accepted accoun�ng principals (GAAP) in Chapter 1, but let's take a closer look at the en��es that create these principles, as well as those responsible for making sure that they are followed in the reports released by publicly traded companies.

Three cri�cal U.S. organiza�ons develop rules, monitor the issuance of financial reports, and police the sales of securi�es to the public (see Table 5.1):

1. The Financial Accoun�ng Standards Board (FASB) develops the GAAP repor�ng principles that all public companies must follow. 2. The Securi�es and Exchange Commission (SEC), a part of the Federal government, monitors company financial reports and makes sure they meet the standards

set by the FASB and the SEC. 3. The Financial Industry Regulatory Authority (FINRA) regulates the actual trading of securi�es and monitors securi�es brokers.

We will take a closer look at the role of each of these en��es. We will also review the role of the Interna�onal Accoun�ng Standards Board (IASB) and the ongoing efforts to develop worldwide financial repor�ng standards.

Financial Accoun�ng Standards Board (FASB)

Since 1973, the Financial Accoun�ng Standards Board (FASB) has developed the standards of financial accoun�ng that all public companies in the United States must follow. These standards govern the prepara�on of financial reports by nongovernmental en��es and are officially recognized as authorita�ve by the SEC (in Financial Repor�ng Release No. 1, Sec�on 101, and reaffirmed in its April 2003 Policy Statement) and the American Ins�tute of Cer�fied Public Accountants (in Rule 203, Rules of Professional Conduct, as amended May 1973 and May 1979).

The primary purpose of the FASB is to ensure that financial reports provide useful informa�on for financial decision making. It does this by establishing and improving standards of financial accoun�ng and repor�ng. Because so many en��es—including lenders, investors, governmental en��es, managers, and employees, as well as the general public—depend on credible, concise, and understandable financial informa�on, the FASB standards enable the efficient func�oning of the U.S. economy. The Enron scandal reminded everyone of the consequences of undermining this system of accurate, reliable, and credible informa�on.

Seven individuals serve on the FASB; most have worked for major accoun�ng firms and major corpora�ons, and some are drawn from academia. In order to serve, a member must sever all �es with his or her former organiza�ons. This helps to ensure the independence of the FASB. Further, members must have demonstrated knowledge of accoun�ng, finance, business, and research, and must show a desire to protect the public interest in ma�ers of accoun�ng and finance.

The seven board members maintain the FASB Accoun�ng Standards Codifica�on, which enables accoun�ng professionals to access the rules and source of authorita�ve standards of accoun�ng and repor�ng that make up the GAAP. One might think of this as the library of accoun�ng standards.

The FASB is part of a financial overview structure (see Table 5.1) that is independent of all other business and professional organiza�ons. That structure includes the Financial Accoun�ng Founda�on, the FASB, the Financial Accoun�ng Standards Advisory Council (FASAC), the Governmental Accoun�ng Standards Board (GASB), and the Governmental Accoun�ng Standards Advisory Council (GASAC). Collec�vely, these groups set rules for accountants to follow when preparing financial reports.

Table 5.1: Financial overview structure

Regulatory body Func�on

Financial Accoun�ng Founda�on A 17-member board that oversees the work of the FASB.

Financial Accoun�ng Standards Board (FASB) Develops GAAP repor�ng principles that all public companies must follow.

Financial Accoun�ng Standards Advisory Council (FASAC)

Advises the board members of the FASB regarding poten�al new projects and helps to set priori�es for exis�ng projects.

Governmental Accoun�ng Standards Board (GASB) Develops repor�ng principles that all governmental en��es must follow.

Governmental Accoun�ng Standards Advisory Council (GASAC)

Advises the board members of the GASB regarding poten�al new projects and helps to set priori�es for exis�ng projects.

Although the FASB strives to accomplish its goals through broad par�cipa�on, its work is subject to oversight by the Financial Accoun�ng Founda�on's Board of Trustees. The Financial Accoun�ng Founda�on is an independent, private sector organiza�on run by a 17-member Board of Trustees from various backgrounds, including users of financial reports, financial report preparers, government financial report preparers, auditors, and academics.

When technical issues arise involving accoun�ng principles, the FASB looks to the FASAC to inves�gate and recommend any needed changes to the GAAP. (In Chapter 1, we discussed how the FASB develops new GAAP rules.) At the �me of this wri�ng, the FASAC had more than 30 members, who represent a broad cross sec�on of the FASB's cons�tuency.

Note that standards for governmental agencies can be different. One significant difference, for example, is the repor�ng of revenue. For a government en�ty, revenue comes primarily from government sources, taxes, or user fees. The financial repor�ng rules for government en��es are developed by the GASB and the GASAC.

Task Box 5.1: Exploring FASB Project Plans

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec… 102/150

The FASB lists all of its current and past projects to revise or improve accoun�ng standards on its website. Visit the Project Plans Archive page and click on the most recent technical plan to find out what issues are currently being considered for revision or which new sec�ons of the GAAP are being proposed. One project involves the rules for revenue recogni�on and is a good example of the work being done by the FASB to converge U.S. rules with interna�onal prac�ces

The world of business is changing, and countries are moving toward one set of accoun�ng rules for interna�onal financial repor�ng. The United States is working toward adap�ng to this new standard; soon, managers in U.S. companies will be required to collect revenue data based on these worldwide rules.

Review the Exposure Dra� for the Revenue Recogni�on prac�ce and note the number of issues being discussed that involve revenue recogni�on. Pick one issue and be prepared to discuss the changes being proposed and how you think that may impact financial repor�ng in the United States.

Review the Proposed Amendments list and pick one for further reading. What aspect of revenue repor�ng did you choose? What key differences are being recommended, and why?

Securi�es and Exchange Commission (SEC)

Since 1934, the SEC has had the statutory authority to establish repor�ng standards for U.S. public companies. The SEC does not actually write the GAAP, but its enforcement of GAAP principles give it power to monitor and improve financial repor�ng.

Managers must collect the financial transac�on data that their companies report based on the GAAP rules. They need to work closely with the accoun�ng liaisons in their offices to meet the requirements of these rules.

Securi�es laws that give the SEC authority over financial repor�ng include:

The Securi�es Act of 1933 (SEC, 2012b): This act is commonly referred to as the "truth in securi�es" law. The act mandates that investors receive financial and other significant informa�on concerning securi�es that are offered for sale to the public. It also prohibits deceit, misrepresenta�ons, and other fraud in the sale of securi�es. The Securi�es Exchange Act of 1934 (SEC, 2012c): This act created the SEC and gave it broad powers to register, regulate, and oversee firms that sold securi�es to the public. This is the act that empowers the SEC to require periodic repor�ng of informa�on by companies that raise money through sales of publicly traded securi�es. Specifically, the act enables the SEC to require companies with more than $10 million in assets whose securi�es are held by 500 or more owners to file annual and other periodic financial reports. As discussed in previous chapters, these reports are available on the SEC's EDGAR database. The Investment Company Act of 1940 (SEC, 2012a): This act regulates the mutual fund industry. It requires companies to disclose their financial condi�on and investment policies to investors when stock is sold on the public markets. The Sarbanes-Oxley Act of 2002 (SEC, 2005): This act mandated reforms to enhance corporate responsibility, enhance financial disclosures, and combat corporate and accoun�ng fraud. The Dodd-Frank Wall Street Reform and Consumer Protec�on Act of 2010 (SEC, 2014): This act reshaped the U.S. financial regulatory system to improve consumer protec�on, increase trading restric�ons, regulate credit ra�ngs, regulate financial products, and improve corporate governance and disclosures. The SEC is s�ll working to implement the new rules under this act. The act contains over 90 provisions that require SEC rulemaking.

Task Box 5.2: Staying Abreast of SEC Wall Street Reform

The SEC s�ll has much work to do to fully implement the Dodd-Frank Wall Street Reform and Consumer Protec�on Act of 2010. Research its progress on implemen�ng this act at h�p://www.sec.gov/spotlight/dodd-frank.shtml (h�p://www.sec.gov/spotlight/dodd-frank.shtml) .

Click on pending ac�ons and review the key issues that are listed there. Pick one of the pending ac�ons and discuss why rules are being considered, how you think those rules will impact financial repor�ng, and how you will collect data for accoun�ng as a manager.

Financial Industry Regulatory Authority (FINRA)

The Financial Industry Regulatory Authority (FINRA) does not play a large role in financial report regula�on; however, it is the largest independent regulator of securi�es firms doing business with the public in the United States. FINRA's mission is to protect investors and ensure market integrity. The authority oversees the U.S. brokerage industry, including, according to its website, more than 4,100 brokerage firms and more than 630,000 brokers.

Interna�onal Accoun�ng Standards Board (IASB)

The Interna�onal Accoun�ng Standards Board (IASB) is essen�ally the FASB's interna�onal counterpart. It is the independent standard-se�ng body of the Interna�onal Financial Repor�ng Standards (IFRS) Founda�on. The board's 15 full-�me members develop and publish Interna�onal Financial Repor�ng Standards. The board members come from various countries and work closely with stakeholders around the world, including investors, analysts, regulators, business leaders, accoun�ng standard-se�ers, and others in the accountancy profession.

Currently, the FASB is working closely with the IASB to develop a single interna�onal standard. However, although most other major countries have adopted an interna�onal standard, or have set a date to do so, no date has been set for the United States.

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec… 103/150

The most recent report by the SEC on this issue was released in July 2012 (Work Plan for the Considera�on of Incorpora�ng Interna�onal Financial Repor�ng Standards into the Financial Repor�ng System for U.S. Issuers; SEC, 2012d). Companies whose stock is issued in other countries can already use the interna�onal standards when complying with repor�ng requirements of the SEC for their U.S. en��es.

Many details regarding how the U.S. and interna�onal systems will be converged must s�ll be worked out between the interna�onal body and the U.S. en��es responsible for se�ng financial repor�ng standards. The en��es have developed the basic elements for financial repor�ng into a "Conceptual Framework for Financial Repor�ng" (IASB, 2008, 2010, 2013). The elements of quality financial repor�ng discussed in the next sec�on were developed using the concepts in this framework (Tysiac, 2013).

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec… 104/150

Relevance and faithful representa�on are the two fundamental qualita�ve characteris�cs of financial repor�ng.

© Baoshan Zhang/iStock/Thinkstock

5.2 Elements of Quality Financial Repor�ng As we have discussed, the primary purpose of financial repor�ng is to provide useful financial informa�on about the company to employees, vendors, suppliers, creditors, present and future investors, and anyone else who depends on accurate financial informa�on to make decisions about the company. Whether this informa�on will be truly useful to readers depends on its quality (Van Beest, 2009).

Developers of the Conceptual Framework for Financial Repor�ng have divided qualita�ve characteris�cs that make financial repor�ng useful into two categories (see Table 5.2):

1. Fundamental qualita�ve characteris�cs: The two key characteris�cs defined as fundamental to all financial reports are relevance and faithful representa�on. 2. Enhancing qualita�ve characteris�cs: The characteris�cs that make financial reports even more useful to readers include comparability, verifiability, �meliness,

and understandability.

Table 5.2: Conceptual framework for financial repor�ng qualita�ve characteris�cs

Fundamental qualita�ve characteris�cs Relevance

Faithful representa�on

Enhancing qualita�ve characteris�cs Comparability

Verifiability

Timeliness

Understandability

In addi�on, the presenta�on of financial repor�ng is limited by two constraints:

1. Materiality: Informa�on is material if its omission or misstatement could influence the decisions a reader might make about the company. For example, a small business with profits of $200,000 that omits informa�on about a $50,000 transac�on is certainly leaving out crucial informa�on that will be material to that company's profits. A major corpora�on with profits in the billions would not likely be materially affected by a $50,000 transac�on that was omi�ed. (We will discuss materiality in more detail later in the chapter.)

2. Costs: If the costs of collec�ng certain informa�on for financial reports exceed the benefits, collec�on is not required. This cost-benefit analysis is done each �me a new repor�ng requirement is developed as part of the U.S. GAAP or the Interna�onal Financial Repor�ng Standards. For example, say a company runs a machine that uses a part that costs just $2 to replace. That replacement is needed about every 100 hours of use. The cost of carefully tracking each replacement in the accoun�ng system would cost more than the part. In a cost-benefit analysis, the company would likely decide not to track each part change because there is li�le added benefit to the task. Instead, the company would track the expenses of buying the supplies.

The costs of providing informa�on include the costs of collec�ng and processing the informa�on, costs of verifying its accuracy, and costs of dissemina�ng it. Users of the informa�on incur addi�onal costs to analyze and interpret it.

There are also costs to consider if decision-useful informa�on is not reported. Readers may not have the informa�on they need to analyze and interpret the report for the purpose of making a cri�cal decision. A decision made without complete informa�on can be costly if the user ends up incurring costs from reduced returns if a poor decision is made, based on incomplete informa�on.

Let's now take a closer look at the qualita�ve characteris�cs being developed by the joint efforts of the FASB and the IASB to ensure that financial reports meet the needs of their users.

Fundamental Qualita�ve Characteris�cs

Fundamental qualita�ve characteris�cs differen�ate between informa�on that is useful and informa�on that is not useful or is even misleading. As noted above, for the informa�on to be useful, it must provide two cri�cal characteris�cs: relevance and faithful representa�on.

Relevance

Financial report informa�on is relevant if it could make a difference in someone's decision-making process. This is likely if the informa�on has a predic�ve value (a value that can be used to form expecta�ons of the future of the company) or a confirmatory value (a value that confirms or changes past or present expecta�ons for the company) or both.

Not all informa�on that has a predic�ve value will be useful to all financial report readers. For example, straight-line deprecia�on of assets may be highly predictable every year, but it may not be useful for assessing a company's cash flow.

The roles of predic�ve and confirmatory informa�on are interrelated. O�en informa�on that has a predic�ve value also has a confirmatory value. For example, informa�on presented about a company's past assets and claims against those assets can help predict a company's ability to take advantage of economic opportuni�es in the future, or to react to unfavorable circumstances that might arise.

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec… 105/150

Faithful Representa�on

Faithful representa�on means that the informa�on presented is complete, neutral, and free from material error. Informa�on is considered complete if it includes all details necessary to make an informed decision. A report is considered neutral as long as there is no bias that leads the reader to a predetermined result, or to take a predetermined ac�on. This does not mean that the informa�on will not influence decision making, because all financial reports do, but the company should not present the informa�on in a way that leads to a conclusion that could have been reached based on informa�on known prior to the prepara�on of the report.

The developers of these basic qualita�ve characteris�cs realize that faithful representa�on will not necessarily mean that the report will be 100% accurate. Financial reports do include management es�mates of various types of assets and liabili�es. For example, the funds es�mated for future re�rement obliga�ons must be based on various assump�ons set by management and actuarial staff.

Instead, for a financial report to meet the criteria of faithful representa�on, the es�mates must be based on appropriate inputs, given the best informa�on available at the �me the report is issued. Some�mes it may be necessary to disclose the uncertainty of the informa�on presented to meet the criteria of faithful representa�on. For example, in the sec�on of the Notes to the Financial Statement where a company discloses poten�al financial impacts of pending legal ac�on, the only informa�on the company can provide is that the lawsuit is pending, without an es�mate of the costs of that ac�on if the company loses in court or se�les the case. It is s�ll cri�cal to report the poten�al of a financial cost at some point in the future to meet the faithful representa�on characteris�c.

These two characteris�cs—relevance and faithful representa�on—together make financial reports more useful for decision making. However, having one without the other can be problema�c. For example, informa�on that is faithfully represented may not be relevant, and therefore not useful for making many decisions.

Enhancing Qualita�ve Characteris�cs

The enhancing qualita�ve characteris�cs—comparability, verifiability, �meliness, and understandability—complement the fundamental qualita�ve characteris�cs to differen�ate between useful and less useful informa�on.

Comparability

Comparability refers to the use of the same accoun�ng policies and procedures (or informa�on about the different policies or procedures used) to compare the financial results of one or more companies. For example, if one company uses the inventory method FIFO (first in, first out) and the company being compared uses LIFO (last in, first out), it is important for readers to know about these differences so they can adjust their analysis. If a company changes its inventory valua�on method, then it needs to adjust prior year financial reports so the informa�on will be comparable from year to year for the same company.

The �me period for the informa�on also must be known so that the reports are clearly comparing apples to apples. For example, if one company reports based on a calendar year and another reports based on a fiscal year that goes from February 1 to January 31, this may affect the numbers.

Since economic condi�ons change from year to year, if the exact same months are not compared, the results will not be useful. For example, a company that uses a calendar year would include January 2012 in the 2012 report, but a company that uses a fiscal year from February 1, 2012, to January 31, 2013, would use January 2013 in the 2012 report. If economic condi�ons of January 2012 were very different from those of January 2013, the results will not be comparable for these two companies.

Comparability does not mean that all financial reports must look alike. Instead, this concept means that if the reports are presen�ng informa�on differently, financial report readers must have the informa�on they need to understand these differences and adjust their analysis in order to compare more than one en�ty or to compare the results of one year to those of another year for the same company.

In many cases, the rules of the U.S. GAAP or the IFRS will require companies to use the same accoun�ng methods for the same type of transac�on, so the informa�on can be comparable.

Verifiability

Verifiability of the quality of the informa�on presented on the financial reports helps demonstrate that the informa�on presented faithfully represents the results of the company. Verifica�on is done within a company using various methods to measure the accuracy of the informa�on. For example, a company may verify its inventory count periodically by doing a physical count of inventory on hand and comparing that to the inventory informa�on in the accoun�ng records. Accountants verify cash flow into and out of the business daily by various checks and balances, to be sure the numbers entered into the system match the deposits made to their banks or other financial ins�tu�ons.

All companies have ways to verify the accuracy of their transac�ons, and auditors review these internal controls as part of their audit and report in the financial report whether they believe improvements are needed. We talk more about the role of the auditors later in this chapter.

Timeliness

Financial reports meet the characteris�c of �meliness provided they are released within an appropriate period to enable employees or managers to make decisions based on the report. For example, managers need �mely reports so they can decide how much addi�onal inventory is needed for the next month. A report that is one month late could result in the company running out of inventory at a crucial �me.

The SEC requires U.S. companies to report their quarterly informa�on 40 to 45 days a�er the close of the quarter. Companies must report their year-end informa�on within 60 to 90 days a�er the end of the calendar or fiscal year. The faster repor�ng �mes are required of the largest corpora�ons, whereas smaller companies have

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec… 106/150

longer to release their reports.

Understandability

Understandability means the informa�on in the financial reports is presented clearly and concisely. Even if detailed lease obliga�on informa�on is included, it should be wri�en in a way that managers and employees—as well as investors and creditors—can understand. If an employee does not understand the lease arrangements, he or she can request addi�onal explana�on from the accoun�ng liaison for that department.

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec… 107/150

Currently there are differences between U.S. and interna�onal financial repor�ng requirements.

© Joris Van Ostaeyen/iStock/Thinkstock

GAAP rules regarding research and development can result in significantly decreased net income because, unlike IFRS rules, costs for both research and development must be expensed in the year of development.

Javier Larrea/age footstock/SuperStock

5.3 How U.S. Repor�ng Requirements Compare to Interna�onal Requirements We discussed the key concepts that both the FASB and the IASB use to ensure quality financial repor�ng, but now let's examine some key differences between how informa�on is reported in the United States and how interna�onal repor�ng agencies require it. These differences can make it difficult to compare U.S. companies to companies based outside the United States. If a manager wants to compare profitability between his or her company and a global company repor�ng under interna�onal rules, it will be cri�cal to understand the differences.

In today's global business environment, many U.S. companies compete with companies from other countries. Some employees working in the United States discover that their company is owned by a foreign en�ty. They may find their company's reports are completed according to interna�onal financial standards. In both cases, U.S. managers need to understand the differences between U.S. and interna�onal repor�ng.

In addi�on, as noted earlier, efforts are underway to converge the U.S. GAAP rules with interna�onal financial repor�ng rules. The project, which is being spearheaded by members of the FASB and IASB, has been in the works for years. There is no indica�on of how much longer it will take, but issues are being converged one by one.

Asset Value

One significant difference between GAAP and the Interna�onal Financial Repor�ng Standards (IFRS) is that IFRS permits the revalua�on of intangible assets; property, plant, and equipment; and investment property. GAAP prohibits revalua�ons except for certain categories of financial instruments that are carried at fair value, such as marketable securi�es.

Many analysts believe that assets are undervalued on the balance sheets of major U.S. corpora�ons that compile their reports based on GAAP, especially when it comes to the value of property and plants. Corporate headquarters and factories that were built 20 to 30 years ago are valued on the balance sheets of U.S. corpora�ons at cost. In many cases, these assets likely have appreciated greatly, even though for some companies the buildings have been depreciated to near zero on the balance sheets.

If U.S. corpora�ons switch to IFRS, there may be a drama�c increase in the value of assets held by some companies, as they adjust the values of their property and plants on their balance sheets.

Revenue Recogni�on

Both GAAP and IFRS require the recogni�on of revenue when an item's ownership is transferred to the buyer of the goods, but GAAP gives much more detailed guidance for specific types of transac�ons. Later in the chapter, we examine the games that some companies play with regard to revenue recogni�on, even under the more detailed GAAP rules. For managers, accurate revenue repor�ng is cri�cal in order to understand the company's profitability and cash availability.

Research and Development

Another key difference between IFRS and GAAP involves how research and development is reported. Under IFRS, research is expensed as a cost of doing business, but development costs are capitalized and amor�zed, which means they are wri�en off over several years. Under GAAP rules, both research and development costs are expensed as incurred.

This policy can have a major impact on a company's bo�om line. For example, suppose a company determines that of the $10 million it spent on bringing a new product to market, $2 million was for research and $8 million was for development of the product a�er research was concluded. Under the GAAP rules, the $10 million would be expensed in each year of the development, based on when the expenses are recognized. Those expenses would decrease net income significantly.

A company opera�ng under the requirements of the IFRS would need to expense the $2 million spent on research as it was spent, but it could capitalize the $8 million and write it off more slowly as an amor�za�on. Depending on the life span given the value of the development, it could be wri�en off over 10 to 15 years or more, reducing the impact of development on the bo�om line.

Inventory

Another key difference between IFRS and GAAP is the way inventory is valued. All companies that file reports under IFRS must use FIFO (first in, first out) or weighted- average inventory valua�on methods, which we discussed in Chapter 2. Those filing under GAAP rules can also use LIFO (last in, first out).

The FIFO type of inventory valua�on assumes that the first item in the door is the first item sold. When the LIFO method is used, the last item bought will be the first item sold. In this case, the most expensive item is likely sold, while the older, cheaper items remain on the shelf.

For example, suppose a hardware store buys hammers for $12 per unit to stock its shelves at the beginning of the year. Six months later, the store sees that the hammer supply is low and buys addi�onal inventory, but now each unit is $12.50. The new units will likely be added to the front of the shelf, so the more expensive hammers would be sold first, while the cheaper hammers would remain on the shelf.

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec… 108/150

In some industries, such as the energy sector, prices go up and down throughout the year. The price of gasoline, for example, is known to fluctuate because of seasonal and other factors. This can impact the net profit differently depending upon whether LIFO or FIFO is used. As prices are going up, such as we see with the hammers, the Cost of Goods Sold would be higher using LIFO. LIFO inventory value would be based on the last hammer sold, so Cost of Goods would be higher and net profit lower. If prices are dropping and LIFO is used, then the Cost of Goods would be lower and net profit higher. But, in the energy sector prices go up and down on a weekly basis. In this type of industry the average cost method will more likely be used.

LIFO can increase the cost of goods sold and decrease net income, making it look like a company made less money and, therefore, reducing the company's income taxes when prices are going up. FIFO results in a lower cost of goods sold and higher net income when prices are going up. The opposite is true when prices are going down.

When comparing companies using two different inventory valua�on methods, determining the actual costs of doing business can be difficult. If all companies were required to use either FIFO or the weighted-average inventory valua�on methods, comparing apples to apples would be easier.

Discon�nued Opera�ons

Under IFRS, if specific opera�ons of an ongoing company are discon�nued, the opera�ons and cash flows must be clearly dis�nguished for financial repor�ng. The company must specify whether the discon�nued opera�on is a separate line of business or geographical area of opera�ons, including whether a subsidiary is acquired exclusively for the purpose of being sold. This happens o�en when a company buys another company for a specific purpose and is not interested in con�nuing every area of the newly acquired company's opera�ons.

Under GAAP, the lines are more blurred in regards to discon�nued opera�ons. A segment, opera�ng segment, repor�ng unit, subsidiary, or asset group can be shown as separate losses for discon�nued opera�ons. Some analysts believe that companies filing under GAAP use this loophole to hide significant problems.

Impairment Charges

Some�mes an asset loses value. For example, a computer manufacturer may have inventory of older models that can no longer be sold at full price because newer, more advanced models are available. Their values become impaired and must be wri�en down.

Under GAAP, when an impairment charge is recorded in inventory, the company cannot reverse the impairment charge if assets subsequently increase in value. Under IFRS, however, the company is allowed to reverse the impairment charge if assets subsequently increase in value.

This can impact both the income statement and the balance sheet, as assets whose values have been impaired are adjusted in later years. Managers need this informa�on to make decisions regarding profitability and the availability of future cash that may or may not be available from these impaired assets.

Task Box 5.3: Preparing for Changes to GAAP

While no date has been set, the U.S. GAAP rules are expected to be merged with interna�onal financial repor�ng rules at some point. PricewaterhouseCoopers, one of the major global accoun�ng firms, periodically prepares excellent reports about poten�al changes. Read its most recent IFRS repor�ng update on the company's website.

Pick an accoun�ng issue discussed by PricewaterhouseCoopers that you think relates to the role of a manager. How would the financial repor�ng for your company be impacted?

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec… 109/150

Personal rela�onships can develop between auditors and company management that call into ques�on the independence of the audit team. To address this issue, PCAOB is considering a regula�on that would mandate regular changes in company auditors.

© Ievgen Chepil/iStock/Thinkstock

5.4 The Auditor's Role Company outsiders need to be sure that the informa�on they see on financial reports is an accurate reflec�on of the company's financial situa�on. This is accomplished by hiring an impar�al third party to review the company's opera�ons and financial statements and to confirm that the reports are materially correct and that proper internal controls are being used. This process is called an audit and is crucial for verifying the accuracy of a company's financial reports.

Every public company that sells stock on one of the public markets must hire an independent cer�fied public accountant (CPA) to audit its financial statements. Managers, employees, investors, financial ins�tu�ons, vendors, suppliers, and everyone else who depends on knowledge about a company's financial status expect these audited statements to be materially correct. The CEO and CFO must approve the financial statements that are ul�mately issued to the public. The auditors' only responsibility is to issue an opinion that the financial statements are materially accurate.

Auditors must abide by the rules set by the Public Company Accoun�ng Oversight Board (PCAOB), which is a private sector, nonprofit corpora�on created by the Sarbanes-Oxley Act to oversee the auditors of public companies. Even though the PCAOB is a private en�ty, it has many government-like regulatory func�ons in rela�on to se�ng rules for auditors and how they do their work, which is similar to the role of the FASB for se�ng GAAP rules. The PCAOB is considering rule changes regarding mandatory firm rota�on, which is discussed in further detail in "New World of Financial Oversight."

The Sarbanes-Oxley Act also requires that public companies with market capitaliza�ons of $75 million or more include an a�esta�on report of their independent auditors on the effec�veness of the company's internal controls over financial repor�ng. This requirement has become part of the audit process.

New World of Financial Report Oversight

Research by Marion McHugh and Paul Polinski in the CPA Journal (2012) indicates that there is value to requiring firms to change their auditors more regularly. In fact, some findings indicate that it is important to change not only the lead auditor but audit firms as well. In this CPA Journal ar�cle, the authors indicate that the PCAOB is looking for ways to improve the quality of audits and whether there is a need for mandatory audit rota�on.

Now that it has been several years since Sarbanes-Oxley passed, the PCAOB has no�ced that there are fewer changes in auditors from year to year, which the PCAOB believes may be due to a reduc�on in firm scru�ny and independence. The PCAOB is considering the costs and benefits of addi�onal regulatory measures.

The authors of this CPA Journal ar�cle believe that "improved disclosures would give audit firms a formal opportunity to demonstrate their independence" (McHugh, 2012, p. 30). They also believe that the necessary changes could result in the PCAOB requiring mandatory audit firm rota�on to ensure independent audits. If this occurs, managers would need to adapt to regular changes in auditors, which would mean a reduc�on in personal rela�onships between auditors and company management.

Consider This:

1. Do you think it is important for auditors and company managers to develop personal long-term rela�onships? Why or why not? 2. Will the public be be�er served by frequent changes of auditors? Why or why not?

Mee�ng the Qualifica�ons

To become a licensed CPA, candidates must complete extensive training. This includes comple�ng at least a bachelor's degree with a major emphasis in accoun�ng, passing a state administered uniform CPA exam, and comple�ng work under the supervision of a CPA to sa�sfy work-experience requirements that vary by state. To keep a current license, CPAs must take con�nuing educa�on courses. The amount of �me devoted to con�nuing educa�on and educa�onal requirements varies by state.

Each state has a board of accountancy that monitors the ac�vi�es of its CPAs. The state boards have the right to revoke or suspend a CPA's license if he violates the laws, regula�ons, or ethics governing CPAs. If a CPA's license is revoked or suspended, she can no longer serve clients as an independent CPA unless she can get her license reinstated.

In order to audit a company's financial statements, a CPA must be in public prac�ce and be an employee of a CPA firm. A CPA's independence from the companies he serves is cri�cal to assure an independent report. Major publicly traded corpora�ons usually use one of the top four CPA firms: PricewaterhouseCoopers, Deloi�e, Ernst & Young, or KPMG.

A good CPA will approach an audit with skep�cism. He may need to challenge management's asser�ons if those asser�ons differ from the evidence collected in the audit. Some�mes independent auditors will have views different from those held by management about how to record a par�cular transac�on or disclose accoun�ng informa�on. When there is a difference of opinion, the auditor must act in the public's interest, not the interest of company management.

If differences cannot be resolved, the audit commi�ee of the company's board of directors may be asked to step in. In rare circumstances, if the auditor cannot come to an agreement with the board, she may resign from the audit and inform the SEC of the issue. In these occasions, the SEC may open an inves�ga�on of the

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec… 110/150

company.

Usually when an auditor resigns in the middle of an audit, the company must send out a no�ce that its financial reports will be delayed. Discussion of an auditor change is typically found in the Notes to the Financial Statements, but it may also be discussed in the Management's Discussion and Analysis sec�on.

The Audit Process

The audit process includes three key steps: defining the scope of the audit, performing fieldwork, and wri�ng the audit report. Let's take a look at each of these crucial steps.

Defining the Scope

Auditors begin by mee�ng with top management and an internal commi�ee of the board of directors (made up of directors appointed to this commi�ee) to discuss the audit's scope and objec�ves. Managers will bring a list of issues that should be reviewed as part of the audit. An audit may include a complete review of the company's opera�ons, or it may focus on just one aspect, such as collec�ons from customers, which would be a limited scope audit.

The objec�ves of a full audit are usually to validate the company's financial statements. The objec�ves of a more focused audit usually involve reviewing the opera�on's efficiency or finding possible internal control problems that might put the company at risk of the� or fraud.

A�er determining the scope of the audit, the auditors meet with key managers to gather informa�on about internal accoun�ng processes, to evaluate exis�ng controls, and to plan how the audit will be conducted inside the company. The internal accoun�ng manager then sends a le�er to the staff involved, announcing the audit and who has been assigned to conduct it. In the first mee�ng with accoun�ng staff, the auditors review the available resources—including personnel, facili�es, and funds—that are allocated to the audit. During these ini�al mee�ngs, those involved iden�fy areas of special concern.

Auditors then meet with the departments being audited, which may include all departments or just a few that are directly involved in the issues being inves�gated. The auditors survey key personnel and review financial reports, files, and other informa�on. The auditors also review each department's internal control structure. This review helps iden�fy any holes in internal control processes and the key areas that need to be tested when audi�ng specific stores or other loca�ons that the company owns.

A�er the preliminary review, the auditors design the process that will be used to collect needed informa�on and to meet the objec�ves set out in the ini�al mee�ngs with top execu�ves and the board of directors.

Performing Fieldwork

Auditors perform fieldwork when they visit a company's individual offices and loca�ons to determine whether the internal controls discussed at the company's top levels are being implemented properly. For example, if a business requires a certain type of coding when an order is charged to a customer's account, and that coding is not being used consistently, some customers may be ge�ng merchandise without being billed.

In the field, auditors watch a company's employees carry out certain tasks to be sure that they are performing them correctly. Addi�onally, auditors review files to be sure all the paperwork is in order to back up reports sent to the central corporate offices. For example, if the company requires a manager's signature before a customer is given a refund, the auditor randomly reviews company refund records to be sure that the signature process is being followed.

Although the top manager at a loca�on likely knows when the auditors will arrive, the rest of the staff is usually surprised by their arrival. Any findings during the fieldwork become part of the dra� audit report.

A�er the auditors complete a preliminary review of the specific loca�on, they randomly review various records to be sure that employees are following internal control procedures. For example, if an auditor is audi�ng a bank's opera�ons, the auditor will want to know whether employees are following the bank's procedures for approving a loan. The auditor will likely check random loan files to be sure all needed approvals are in place.

The type of fieldwork that is required of auditors depends on the business type and the audit's scope. Auditors for a bank will visit offices in the corporate headquarters as well as bank branches to complete their fieldwork. Auditors for a corpora�on with retail stores will do their fieldwork in the corporate headquarters, regional headquarters, and individual stores. If the scope of the audit is just to review the customer order and bill-paying process, the fieldwork may take place only in the corporate accounts receivable sec�on of the accoun�ng department.

Wri�ng the Report

As the auditors work in the field, they discuss any significant discrepancies with top management. Managers can comment on the findings before auditors submit a final report to the opera�ng managers, top execu�ves, and board of directors. Managers are usually given an opportunity to submit their own comments in areas of discrepancy.

Auditors o�en work with management to determine how best to resolve any problems before they complete their final audit report. If a problem can be easily resolved, they can do so verbally. If the problems are more serious or complex, auditors compile wri�en reports and circulate them to managers, corporate execu�ves, and board members. These reports summarize the auditors' findings, iden�fying problems and making recommenda�ons, before the auditors turn in their final report.

Most companies work to fix problems internally to avoid being reported to their outside stakeholders: investors, creditors, employees, vendors, and suppliers. If the auditor concludes that changes need to be made within the corpora�on, managers submit their plans to improve processes based on the auditor's recommenda�ons.

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec… 111/150

If, for some reason, managers disagree with the auditor, they have to explain in the final report why they disagree and what they plan to do to fix the problem.

Top management or members of the audit commi�ee of the board of directors usually find out about problems long before they are detailed in the business press or on the front page of the newspaper, as some company scandals are. Audit reports from fieldwork are not released publicly, so when scandals do make it to the front pages, it is usually a�er a whistle-blower comes forward or the SEC announces an inves�ga�on.

The summary of the audit report can be found in the annual report, as discussed in Chapter 1. The summary is usually one or two pages and does not provide significant detail about the audit's findings.

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec… 112/150

Crea�ve accoun�ng led to the 2008 bankruptcy of Lehman Brothers.

Zak Brain/SIPA/Associated Press

5.5 Crea�ve Accoun�ng Even a�er new controls were put in place following the Enron scandal, there have been instances of "crea�ve accoun�ng" being used to misinform the public. The 2007/2008 mortgage scandal and demise of financial ins�tu�ons, such as at Lehman Brothers, shows that repor�ng problems can s�ll arise. (For more informa�on about the dissolu�on of Lehman Brothers, read "World of Business.")

Former SEC Chairman Arthur Levi� calls crea�ve accoun�ng techniques "accoun�ng hocus-pocus" (Carmichael, 1999, online). He exposed the crea�ve accoun�ng techniques we will discuss here from accoun�ng prac�ces he witnessed as chairman of the SEC over seven and a half years, from July 1993 to February 2001.

World of Business

Destruc�on of a Corporate Powerhouse

In 2007, Lehman Brothers was the fourth largest investment bank in the United States, but by September 2008, it was forced to file for bankruptcy protec�on. How did such a major bank fall so hard—so fast?

Crea�ve accoun�ng played a major role in its demise. The bank borrowed billions of dollars to buy subprime mortgages during the housing market boom between 2001 and 2007. Lehman used a financial trick called a repurchase agreement, which was a type of short-term loan, to sell these mortgage securi�es and agreed to buy them back in the future. Then, instead of showing these as loans on its financial statements, it showed them as sales and counted them as revenues.

As the subprime market collapsed—and Lehman didn't have the money to buy back the securi�es—the game of crea�ve accoun�ng was exposed. The securi�es were shown to be worthless to the en��es that bought the mortgage securi�es from Lehman, but Lehman Brothers had no cash to buy them back. The companies holding the mortgage securi�es demanded that Lehman buy them back, as required by the repurchase agreements, but Lehman was out of cash. Lehman was forced to file for bankruptcy protec�on.

Source: Onaran, Yalman and Scinta, Christopher. (2008, Sept. 15). Lehman Files Biggest Bankruptcy Case as Suitors Balk. Bloomberg. Retrieved from h�p://www.bloomberg.com/apps/news?pid=newsarchive&sid=awh5hRyXkvs4. (h�p://www.bloomberg.com/apps/news?pid=newsarchive&sid=awh5hRyXkvs4)

Consider This:

1. Should banks that manage money for others face stricter scru�ny? Why or why not? 2. The mortgage securi�es scandal has resulted in fines for many banks and more are likely to come. Do you think these fines are warranted? Why

or why not?

Big Bath Charges

A company may "clean up" its balance sheet by giving it what Arthur Levi� has called the "big bath" (Carmichael, 1999, online), meaning the company washes away past financial problems. When earnings drop significantly, some execu�ves hope that Wall Street will look beyond a one-�me loss reported in one quarter or one year and focus on future earnings.

For example, General Motors, which filed for bankruptcy in 2009, used the big bath strategy to a�empt to clean out its losing assets and reduce the impact of repor�ng its income losses. In August 2008, GM reported $15.5 billion in net losses for the second quarter, including $9.1 billion in special items, such as write-downs for the value of vehicles and costs related to se�ling a strike of one its suppliers.

Companies some�mes use this prac�ce when they decide to restructure some parts of their business—for example, when two divisions of a company merge or a single division is split into two. During the restructuring process, execu�ves can clean up any problems in previous repor�ng by including the losses not reported in previous quarters as part of the restructuring.

This "cleaning" process may also include hiding past financial repor�ng problems. The accoun�ng problems taken off the books can include deliberate or nondeliberate accoun�ng errors made during previous repor�ng periods. By including these problems as part of the restructuring, companies hope to hide their previous errors as part of a larger change.

Crea�ve Acquisi�on Accoun�ng

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec… 113/150

Levi� refers to crea�ve acquisi�on accoun�ng as "merger magic" (Carmichael, 1999, online) because companies use acquisi�ons to hide their financial problems. Companies may use their repor�ng of mergers in a way similar to the big bath. They hide previous repor�ng problems as part of the merger, hoping the previous errors will not be no�ced.

This accoun�ng trick is par�cularly effec�ve when the acquisi�on consists of a stock exchange rather than a cash exchange. By se�ng a stock price for an acquisi�on that enables a company to hide previous problems, such as losses that were not reported, a lot of past accoun�ng problems can "disappear," thanks to the higher stock price.

Usually, company management can erase financial problems in a popular write-off called in-process research and development, which is a one-�me charge men�oned in the notes to the financial statements detailing an acquisi�on. Ge�ng rid of previous repor�ng problems with this charge removes any future earnings drag of repor�ng the losses individually and makes future earnings statements look be�er (Giherai, 2011).

Miscellaneous Cookie Jar Reserves

Companies that use liabili�es rather than revenue to hide problems do so by using what Levi� calls "cookie jar reserves" (Carmichael, 1999, online). When using this technique, company management makes unrealis�c assump�ons about the company's liabili�es.

In a good year, a company assumes that its sales returns will be much higher than they have been historically. These assump�ons are "banked" as a liability, which means they are added to an accrual account that can be adjusted in a later year.

For example, a company would reduce revenues using an account called "Allowance for Bad Debts," which is set up to write off invoices customers do not pay. These supposed "bad debts" can be reversed in the future with an accoun�ng entry. When a business has a bad year and needs to manage its earnings, it can massage those earnings by reducing the actual bad debts, using some of the banked bad debts from the cookie jar.

Revenue Recogni�on

Another way in which companies can play games with their financial reports is to take liber�es when repor�ng their revenue. We discussed the official rules for repor�ng revenue in Chapter 3, but let's take a look at how companies try to skirt the rules.

Note that if a company uses the decep�ve accoun�ng techniques discussed here, it will probably not become known un�l an insider exposes the problem. We explore some of the most common revenue recogni�on techniques that were exposed in the late 1990s and early 2000s.

Recognizing Revenue Before Shipping

In some cases, a company considers goods that have been ordered but not yet shipped to be part of its revenue earned. In the long term, this system can create not only an accoun�ng nightmare but also a nightmare for managers throughout the company. Orders can get severely backlogged, and ul�mately, the company may experience problems sa�sfying the delivery of products to its customers on �me.

Addi�onally, this prac�ce can have a big impact on a company's bo�om line. Accrual accoun�ng is specifically designed to match revenue with expenses each accoun�ng period. As more and more goods that are ordered but not shipped build up, financial reports overstate the company's revenue and understate expenses un�l the decep�on is exposed. Eventually, the company will have to admit its game-playing and restate its net income, which will likely result in a profit reduc�on or possibly even a loss.

Ul�mately, execu�ves and managers only delay the inevitable when they play the sales before shipping game. Some do it to maintain their bonuses as long as possible. Others do it because they do not want to face the reality of the company's financial posi�on.

Sending Goods Not Ordered

Some companies get even more aggressive with their decep�on, recognizing revenue on goods that have been shipped but that customers have not ordered yet. Companies that use this technique commonly ship items for inspec�on or demonstra�on purposes in the hope that customers will buy the product. This tac�c can help a company meet its revenue for the upcoming repor�ng period because it counts these unordered goods as sales, even though the products have not been sold. However, if some customers receive the goods, decide not to purchase them, and return the merchandise, the company must subtract these sales from its revenue during the next period.

As the problem snowballs, the company has to ship more and more orders without actually having the sales to meet its revenue expecta�ons. Each month, it has to reverse a greater percentage of its revenue, and as a result, it has to make up the shor�all by shipping an even greater number of units without actual orders. Eventually, the company will not be able to keep up the decep�ve prac�ces because third party distributors or retailers won't accept any more inventory. The company will have to correct its financial statements, lowering the amount it reported as revenue and reducing its net income.

Extending the Repor�ng Period

Some companies try to meet Wall Street's revenue expecta�ons by keeping their books open for a few days—or even a few weeks—into the next repor�ng period in order to generate last-minute sales. This tac�c eventually creates major problems because it takes sales that should be reported as income during the next repor�ng period. Eventually, the company has to reveal its decep�ve prac�ces because it has to leave its books open longer and longer each period to meet the next period's expecta�ons. When it becomes impossible to meet SEC repor�ng requirements, the company must reveal its decep�ve prac�ces or file SEC reports late, which can be an even bigger problem for management.

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec… 114/150

Channel Stuffing

Channel stuffing is a way for companies to get more products out of their manufacturing warehouses and onto distributors' and retailers' shelves. The most common method is to offer distributors large discounts so that they stock up on inventory. Distributors buy more product than they expect to sell because they can get it cheaper, then sell the product to their customers; however, several months or even a year may pass before all the products are sold. If the products do not sell, distributors may have the right to return the product.

Although this strategy is a legi�mate type of revenue, it will come back to haunt the company in later accoun�ng periods, when distributors have so much product on their shelves that they do not need to order more. At some point in the future, new orders drop, which means fewer sales and a drop in revenue reported on the income statement.

Side Le�ers

Some�mes companies make agreements with their regular customers outside the documenta�on used for the corporate repor�ng of revenue. This agreement is called a side le�er. The side le�er involves the company and customer changing terms behind the scenes, such as allowing more liberal rights of return, or rights to cancel orders at any �me that can, essen�ally, kill the sale. Some�mes these agreements go as far as excusing the customer from paying for the goods. Companies do this to make their revenue numbers look be�er on the next income statement, even though the income will need to be reversed in the future. The company's managers hope that they will be able to replace these sales in a future accoun�ng period.

In all cases, the side le�er terms eventually result in turning revenue that was recognized on a previous income statement into a nonsale, either by the return of goods or the extension of credit beyond a 12-month payment period. This prac�ce makes revenue from these sales look be�er ini�ally, but the revenue is later subtracted when the goods are returned.

Rights of Return

Giving customers liberal return rights is another way of ge�ng them to order goods, even when they are not sure if they will be able to resell them. By offering distributors or retailers terms that allow them to order goods that they can return as much as 12 months later if they do not sell, the sales, in essence, are not really sales, and they should not be recognized as revenue on a company's financial report.

Rights of return are offered to most customers, but when payment for goods depends on the need for the distributor or retailer to first resell the goods, the recogni�on of that revenue is ques�onable.

Related-Party Revenue

Related-party revenue comes from a company selling goods to another en�ty in which the seller controls the management of opera�ng policies. For example, if the parent company of a toy manufacturer sells the raw materials needed for manufacturing the toys to its subsidiary, the parent company cannot count that sale of raw materials as revenue. Whenever one party can control or significantly influence the decision of the en�ty that wants to buy the goods, a company cannot recognize the sale as revenue.

These related-party sales do not meet the SEC's requirement for an arm's-length transac�on, which is a transac�on that involves a buyer and a seller who can act independently of each other and have no rela�onship to each other. The SEC requires that companies only recognize sales with third par�es that cannot be controlled by the party that plans to recognize the sale as revenue. Companies are not permi�ed to record sales to their affiliates or other related en��es as part of their recognized revenues.

Upfront Service Fees

Companies that collect upfront service fees for services over a long period of �me, such as 12, 24, 36, or 60 months, must be careful about how they recognize this revenue. If the company collects fees to service equipment upfront, these fees cannot be counted as revenue when the money is collected. The SEC requires that such companies recognize their revenue over �me, as the fees are earned. Companies that recognize this type of revenue all at once are prematurely recognizing revenue.

Exploita�on of Expenses

If a company is playing games with its expenses, the evidence for it is most likely to appear in its capitaliza�on or amor�za�on policies. Details about these policies are located in the notes to the financial statements. We discussed how to find this informa�on in Chapter 2 and Chapter 3, where we examined deprecia�on and amor�za�on on the balance sheet and income statement.

Companies that want their bo�om line to look be�er may shi� the way that they report deprecia�on and amor�za�on, which are the tools they use to account for an asset's use and to show the decreasing value of that asset. To make their net incomes look be�er, companies can play games with the amounts they write off. They do so by wri�ng off less than they should and lowering expenses.

In addi�on to deprecia�on and amor�za�on schedules, companies can play games with expenses when repor�ng some types of adver�sing, research and development costs, patents and licenses, asset impairments, and restructuring charges. In some cases, companies can capitalize (spread out) their expenses over a number of months, quarters, or years. Spreading out expenses can improve a company's bo�om line because the expenses will be lower in the first year they're incurred, and lower expenses mean repor�ng more net income. So the key ques�on is whether a company is spreading its expenses out properly or improperly managing its bo�om line.

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec… 115/150

Worldcom filed for bankruptcy in 2002 a�er misrepresen�ng its finances in order to hide losses.

Rogelio Solis/Associated Press

Recognizing Overstated Assets

Companies can also make themselves look financially healthier by oversta�ng assets. The company may report that it has more cash due than it really does or that it holds more inventory than is actually on its shelves. The company may also report that the value of its inventory is greater than it really is.

Accounts Receivable

The accounts receivable sec�on of the financial report can be used to hide the repor�ng of premature or fic��ous revenue recogni�on. Many of the games are related to the issues of revenue recogni�on discussed above.

There are other ways that a company can overvalue its accounts receivable. Another account that offsets the amount in accounts receivable is the allowance for doub�ul accounts. At the end of each accoun�ng period, the company iden�fies past-due accounts that probably will not get paid and adds the value to the allowance for doub�ul accounts, which reduces the value of accounts receivable.

A company that wants to play with its numbers and indicate that its financial posi�on is be�er than it appears will reduce the amount it sets aside for doub�ul accounts. Gradually, the number of days the company takes to collect on its accounts receivable goes up as more and more late or nonpayers are le� in accounts receivable. Eventually, the number of days it takes for the company to collect on its accounts receivable goes up, and the amount of cash it takes in from customers who are paying off their purchases bought on credit slows down (Magrath 2002).

We explore how to test the trend for accounts receivable in Chapter 6.

Inventory

As we discussed in Chapter 2, companies can use one of five different inventory valua�on methods, and each one yields a different net income. However, inventory policy is not the only way a company can shi� the value of its inventory on the balance sheet. Other common methods include the following:

Oversta�ng physical count: Although this is absolute fraud, some companies choose this tac�c to improve the appearance of their balance sheets. Companies some�mes alter the actual count of their inventory; other �mes they do not subtract a decrease in inventory from the physical count. Companies may also leave damaged goods in the inventory count even though they have no value. Delaying an inventory write-down: Company management periodically writes down the value of its inventory when they determine that the products are obsolete or slow-moving. Because the decision to write down inventory is up to management, during a rough year, the company may delay wri�ng down inventory to make its numbers look be�er.

We explore how to test whether inventory could be the object of financial game-playing by calcula�ng the number of days inventory is held in Chapter 6.

Undeveloped Land

Land never depreciates, but financial report readers o�en do not know where the land that a company owns is located, so they can never truly assess the value of undeveloped land on a balance sheet. This fact allows a lot of room for crea�ve accoun�ng and leaves the financial reader in the dark when it comes to finding this problem. Unfortunately, in a sketchy situa�on, all financial report readers can do is wait for a whistle-blower to expose it.

Undervalued Liabili�es

Undervaluing liabili�es can make a company look healthier to financial report readers, but this decep�on is likely to lead the company down the path to bankruptcy. Games played by missta�ng liabili�es frequently involve large numbers and hide significant money problems. For example, Enron's game-playing in this area was exposed to the world when it filed for bankruptcy, as discussed at the beginning of this chapter. Worldcom also used crea�ve accoun�ng to hide its liabili�es, as discussed in "World of Business."

World of Business

Making Liabili�es in Assets

Worldcom, the second largest telecommunica�ons company in the United States in 2001, was forced to file for bankruptcy protec�on in July 2002 with a debt load of $41 billion. Worldcom had reported $107 billion in assets in 2001, but not everything listed as an asset was actually an asset. The company turned about $4 billion of expenses into property, plant, and equipment assets to make its finances look be�er and hide its financial problems.

The company did this by repor�ng opera�ng expenses for leasing other telecommunica�on companies' phone lines—primarily those that connect homes and businesses to the global communica�ons network it operated—as capitalized leases. This meant these lines could be added to the balance sheet as property, plant, and equipment. So instead of being charged as opera�ng expenses that would reduce revenue, they were added as capital expenditures that increased assets on the balance sheet. This was just one of the crea�ve accoun�ng games the company played to hide its losses.

Source: Jones, M. (Ed.). (2011). Crea�ve accoun�ng, fraud and interna�onal accoun�ng scandals. Hoboken, NJ: John Wiley & Sons.

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec… 116/150

Consider This:

1. Do you think government agencies do enough to protect individuals from crea�ve accoun�ng games? Why or why not? 2. What types of protec�ons do you think the U.S. Congress should consider to improve the accuracy and dependability of financial repor�ng?

Accrued Expenses Payable

Any expenses that a company has incurred but not yet paid by the end of an accoun�ng period are accrued (posted to the accounts before cash is paid out) in the current period, so these expenses can be matched to current period earnings. This amount is added to the liability side of the balance sheet. Unpaid expenses can include just about any expense for which the company gets a bill and has a number of days to pay, such as administra�ve expenses, benefits, insurance, salaries, and u�li�es.

If the bill arrives during the last week before a company closes its books, the company most likely will accrue it rather than pay it. Most firms cut off paying bills several days before they close their books so the staff can concentrate on closing the books for the period.

If a manager needs to improve the net income of a company, he or she can manage the numbers by not accruing bills and instead paying them in the next accoun�ng period. The problem with this strategy is that the next accoun�ng period has more expenses charged to it than the company actually incurred during that accoun�ng period. The expenses will be higher, and therefore, the net income will be lower in the next repor�ng period. The manager will only delay the bad news and possibly not make the changes needed to improve profitability in the next period.

Con�ngent Liabili�es

Con�ngent liabili�es are liabili�es that a company should accrue when it determines that an event is likely to happen. For example, if the company is party to a lawsuit that it lost and the winner was awarded damages, the company should accrue the liability as a con�ngent liability.

A company must determine two factors before it can list a con�ngent liability on its balance sheet:

1. The company deems it is probable that it will be held liable. 2. The company can reasonably es�mate the costs that will be incurred.

If the company has not determined these two issues, a note about the con�ngency is usually found in the notes to the financial statements. Read the notes about con�ngencies and research further any items the company may not be fully disclosing. Managers need to be aware of legal se�lements that may impact the availability of cash.

Task Box 5.4: Examining the SEC's Accoun�ng and Audi�ng Enforcement Releases

Learn how to research companies that may be playing games with their numbers by searching Accoun�ng and Audi�ng Enforcement Releases (h�p://www.sec.gov/divisions/enforce/friac�ons.shtml) (AAERs), posted on the SEC website. Use this search feature to find any releases that the SEC may have issued since 1999.

AAERs detail criminal ac�ons, civil ac�ons, and cease-and-desist proceedings, and they explain how the company or individual must correct its current repor�ng prac�ces. The AAERs also outline any penal�es the SEC imposes.

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec… 117/150

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec… 118/150

Summary and Resources

Chapter Summary

Various regulators seek to ensure that the public receives accurate and reliable informa�on in financial reports. This is managed by using generally accepted accoun�ng principals (GAAP) that all companies must follow. The elements of quality financial repor�ng are developed as concepts by the interna�onal regulatory communi�es led by the IASB and the FASB. These bodies have iden�fied two fundamental qualita�ve characteris�cs (relevance and faithful representa�on) and four enhancing qualita�ve characteris�cs (comparability, verifiability, �meliness, and understandability). Two constraining characteris�cs include materiality and cost. There are numerous differences in how informa�on is reported in the United States versus requirements of interna�onal repor�ng agencies. As the business world becomes more global, managers need to understand the differences between financial informa�on reported by U.S. companies and the results that companies report based on interna�onal rules. Independent CPAs help to enable the development of quality financial reports through the audit process. The audit process consists of three steps: defining the scope of the audit, performing fieldwork, and wri�ng the audit report. There are numerous crea�ve accoun�ng tricks companies use to misinform the public. These crea�ve accoun�ng techniques, referred to as "hocus-pocus accoun�ng" by former SEC Chairman Arthur Levi�, include false repor�ng of revenue, expenses, assets, and liabili�es.

Takeaways for Chapter 5

Managers need to be aware of the accoun�ng rules even if they are not accountants. The financial transac�ons that they manage must be reported according to the GAAP rules. If they work for an interna�onal company, they may need to know IFRS rules. As the business world becomes more global, managers need to read financial informa�on from both U.S. companies and companies based in other countries. They need to be aware of the repor�ng differences. Companies can and some�mes do play games with the numbers. Managers and employees should be aware of the accoun�ng tricks that are some�mes used and determine which might be acceptable in some circumstances, and which are not acceptable under any circumstances.

Discussion Ques�ons

1. A financial analyst is working for a company and discovers that the sales manager is recognizing revenue for sales that have not yet been completed in order to meet his numbers for the month. What would you advise this person to do?

2. A warehouse manager discovers a shelf of broken product that is s�ll counted as part of inventory. What should this person do? 3. A salesman has made his first sale and arranged for inventory to be sent to a distributor who will then sell the products to retail outlets. The distributor does not

actually pay for the products un�l the products are sold to the retailers. When should this sale be recognized as inventory? If recognized earlier, how does this impact the financial report?

4. An execu�ve assistant has been asked by his manager to research the asset values of companies in a par�cular industry. The manager wants him to include both U.S. companies and companies based outside the United States. What differences must the execu�ve assistant be aware of to make this comparison? How will these differences impact the balance sheet?

5. Auditors have come into a department as part of a company-wide audit prior to issuing an opinion for the company's financial reports. What should the staff expect the auditors to do?

Further Reading/Resources

American Ins�tute of CPAs (h�p://www.aicpa.org/Pages/default.aspx/ )

Carmichael, D. R. (1999, October). Hocus-pocus accoun�ng. Journal of Accountancy. Retrieved from h�p://www.journalofaccountancy.com/Issues/1999/Oct/carmichl.htm (h�p://www.journalofaccountancy.com/Issues/1999/Oct/carmichl.htm)

Center for Audit Quality (h�p://www.thecaq.org/)

Financial Accoun�ng Standards Board: h�p://www.fasb.org/

Financial Accoun�ng Standards Board [FASB]. (n.d.). Interna�onal convergence of accoun�ng standards—Overview. Retrieved from h�p://www.fasb.org/jsp/FASB/Page/Sec�onPage&cid=1176156245663 (h�p://www.fasb.org/jsp/FASB/Page/Sec�onPage&cid=1176156245663)

Financial Industry Regulatory Authority: h�p://www.finra.org/

Jones, M. (Ed.). (2011). Crea�ve accoun�ng, fraud and interna�onal accoun�ng scandals. Hoboken, NJ: John Wiley & Sons.

Interna�onal Accoun�ng Standards Board (h�p://www.ifrs.org/The-organisa�on/Pages/IFRS-Founda�on-and-the-IASB.aspx)

McLean, B., & Elkind, P. (2003). The smartest guys in the room: The amazing rise and scandalous fall of Enron. New York: Por�olio.

PricewaterhouseCoopers. (2013 Update). IFRS and U.S. GAAP: Similari�es and differences. Retrieved from h�p://www.pwc.com/us/en/issues/ifrs- repor�ng/publica�ons/ifrs-and -us-gaap-similari�es-and-differences.jhtml (h�p://www.pwc.com/us/en/issues/ifrs-repor�ng/publica�ons/ifrs-and-us-gaap-similari�es- and-differences.jhtml)

U.S. Securi�es and Exchange Commission: h�p://www.sec.gov/index.htm

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec… 119/150

U.S. Securi�es and Exchange Commission Accoun�ng and Audi�ng Enforcement Releases (h�p://www.sec.gov/divisions/enforce/friac�ons.shtml)

U.S. Securi�es and Exchange Commission [SEC]. (2014, January 16). Implemen�ng the Dodd-Frank Wall Street Reform and Consumer Protec�on Act of 2010. Retrieved from h�p://www.sec.gov/spotlight/dodd-frank.shtml (h�p://www.sec.gov/spotlight/dodd-frank.shtml) .

U.S. Securi�es and Exchange Commission [SEC]. (2012, July 13). Work Plan for the considera�on of incorpora�ng interna�onal financial repor�ng standards into the financial repor�ng system for U.S. issuers: Final staff report. Retrieved from h�p://www.sec.gov/spotlight/globalaccoun�ngstandards/ifrs-work-plan-final- report.pdf (h�p://www.sec.gov/spotlight/globalaccoun�ngstandards/ifrs-work-plan-final-report.pdf)

Watkins, T. The rise and fall of Enron. San Jose State University, Department of Economics [Website]. Retrieved from h�p://www.sjsu.edu/faculty/watkins/enron.htm (h�p://www.sjsu.edu/faculty/watkins/enron.htm)

Key Terms

Click on each key term to see the defini�on.

arm's-length transac�on (h�p://content.thuzelearning.com/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/c

A transac�on that involves a buyer and a seller who can act independently of each other and have no rela�onship to each other.

cer�fied public accountant (CPA) (h�p://content.thuzelearning.com/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/c

Accountant who has passed the Uniform Cer�fied Public Accountant exam and completed required educa�on and experience requirements. Only CPAs are licensed to provide public opinions on financial statements.

confirmatory value (h�p://content.thuzelearning.com/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/c

A quality that relevant financial report informa�on has when it can confirm or change past or present expecta�ons for the company.

con�ngent liabili�es (h�p://content.thuzelearning.com/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/c

Liabili�es that a company should accrue when it determines that an event is likely to happen.

Financial Industry Regulatory Authority (FINRA) (h�p://content.thuzelearning.com/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/c

Organiza�on that regulates the actual trading of securi�es and monitors securi�es brokers.

material (h�p://content.thuzelearning.com/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/c

If an omission or misstatement could influence the decisions a financial report reader may make about the company, that informa�on is described as material.

predic�ve value (h�p://content.thuzelearning.com/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/c

A quality that relevant financial report informa�on has when it can be used to form expecta�ons of the future of the company.

Public Company Accoun�ng Oversight Board (PCAOB) (h�p://content.thuzelearning.com/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/c

A private-sector, nonprofit corpora�on created by the Sarbanes-Oxley Act to oversee the auditors of public companies. Even though the PCAOB is a private en�ty, it has many government-like regulatory func�ons in rela�on to se�ng rules for auditors and how they do their work, which is similar to the role of the FASB for se�ng GAAP rules.

related-party revenue (h�p://content.thuzelearning.com/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/c

Revenue that comes from a company selling goods to another en�ty in which the seller controls the management of opera�ng policies. For example, if the parent company of a toy manufacturer sells the raw materials needed for manufacturing the toys to its subsidiary, the parent company cannot count that sale of raw materials as revenue.

Securi�es and Exchange Commission (SEC) (h�p://content.thuzelearning.com/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/cover/books/AUOMM622.14.1/sec�ons/c

8/12/2019 Print

https://content.ashford.edu/print/AUOMM622.14.1?sections=cover,fm,abouttheauthor,acknowledgements,preface,ch01,sec1.1,sec1.2,sec1.3,sec… 120/150

The part of the Federal government that monitors company financial reports and makes sure they meet the standards set by the FASB and the SEC. The agency also enforces and regulates the securi�es industry, which includes the stock and op�on markets.