SUBJECT: ACCY305 - Financial accounting III

9.2Explain what is meant by 'earnings management'. (LO2)

9.6Why, and in what circumstances, would a management team consider engaging in big bath accounting? (LO3)

9.13Table 9.1 presents examples of some common accounting decisions, and how companies following a conservative, moderate, aggressive or fraudulent strategy might use these to manage earnings. Make a similar table and complete it in relation to the following accounting decisions:

(a)revenue recognition from services

(b)intangible assets

(c)impairment of non-current assets

(d)revaluation of non-current assets.

(LO2)

Conservative

Moderate

Aggressive

Fraud

Revenue recognition from services

Intangible assets

Impairment of non-current assets

Revaluation of non-current assets

Case study 9.1

The ethics of earnings management

Questions

1.Why would the NZSO wish to smooth income?

2.Were the earnings management techniques the NZSO used ethical? Explain your answer.

3.What factors would you consider when determining whether such a decision was ethical?

(LO3, LO4 and LO5)

Contemporary issue 1.3

Questions

1.This article explicitly refers to earnings management research. How has this research been used in this article to assist in explaining the Dick Smith failure?

2.The article states 'If one subscribes to the conclusions within accounting research'. This proviso implies that others may question the conclusions of the research used in this article. Can you think of reasons why particular theories or research would not be accepted?

3.This article states that the auditors, Deloitte, questioned the rebates, realised that inventory values were too high, yet certified that the company was a going concern. A review of the 2015 annual report indicates that inventory represented almost 60% of total assets and was twice the net asset amount. However, in this report there is no mention of these rebates or their impact on profit and the audit report does not suggest any issues of concern. Referring to the previous definition of professional judgement in this chapter, in your opinion what elements in that definition may not have adequately been practiced?

3. The definition in the text from the American Accounting Association defines professional judgment as:

Professional judgment is a process used to reach a wellreasoned conclusion that is based on the relevant facts and circumstances available at the time of the conclusion. A fundamental part of the process is the involvement of individuals with sufficient knowledge and experience. Professional judgment involves the [clarification of issues and objectives, and the] identification, without bias, of reasonable alternatives; therefore, careful and [unbiased] consideration of information that may seem contradictory to a conclusion is key to its application. In addition, both professional scepticism and objectivity are essential to the process and to reaching an appropriate conclusion.

Professional judgment would have been required to make decisions regarding:

The disclosure and accounting for the rebates

The (over) valuation of inventory

Assessment of whether the company was a going concern.

The article states Deloittes questioned (or was aware of some of these issues), but ultimately did not exercise their professional judgment to, for example, require disclosure or changes in accounting for the rebates (or indicate going concern basis dubious).

In relation to definition could be argued that:

Given relevant facts and circumstancesat the timeconclusion reached was not 'well- reasoned".

Failure to consider information carefully or in unbiased way

Did not exercise professional scepticism or objectivity.