Tecniques And Issues Associatted With Company Financial Earnings Quality (Case Study Sample)

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Abstract
The purpose of this study is to describe the issues and techniques related to earnings quality. An in-depth analysis has been carried out to examine the financial statements of Nuware .Inc. and how to manipulate various earnings quality using accounting techniques.
In this study an evaluation of accrual based earnings and real earnings management accounting approaches are discussed. We pick on the examples of the application of such methods and their relevance to Nuware. Inc.
The financial statements of the company are analyzed and various issues are cited based on its financial performance. Earnings of Nuware are restated and comparison is done to evaluate the financial performance of both companies. Items in the balance sheet which are misrepresented in Nuware financial statements are identified and corresponding accounting calculations are done.
These items are then compared with same items in the financial statement as prepared by R. P. Stuart.
This study ends with a discussion on the areas of balance sheet which conservative accounting techniques could be applied.
1)
Describe techniques and issues associated with earnings quality. Give six specific examples of how to manipulate earnings quality by picking the appropriate accounting technique.
Accounting concepts and techniques are important in an organization since they surround planning and budgeting, short and long term decision making, and operational measurement of performance. Based on Financial accounting analysis of financial data, it’s important in arriving at key management decisions.
Based on our analysis on the issues affecting the earnings Quality, we discovered various violations in accounting techniques.
Financial planning, the main objective of each business venture is maximizing profits (Colin, 2006). This is achieved by making viable and sound financial planning. For business success, financial planning is an important tool in achieving business objectives. Wyburn Malone on recognizing that the business had flopped due to lose of its chairman, planned on how to ensure business growth over the coming years. There was a violation of accounting techniques in recognition of growth emanating from the business focusing solely on building the institutional side of the business.
Financial statement analysis, this refers to income statement and balance sheet analysis. These statements are analyzed for different periods, this analysis assists the management ascertain the rate of business growth (Everet et al, 1996). Such analysis is done through comparative financial statements. In the case of the two firms, financial statements are presented in strict conformity with the GAAPs. However, the methods of valuation adopted by the two firms differ. In case of Nuware, by Sears, depreciation is provided principally using the straight line method, where the useful life of furniture and equipment is taken as three years contrary to R. P. Stuarts who uses useful life of 2 to 10 years on furniture and equipment (Simko, 2004, p.11).
In the organization’s books of accounts, Sears had been accused of using his credit receivable accounts and available accounting discretion to smooth earnings. This violation from the use of GAAPs is unethical and is improper recognition of accounting items. This is not attributable by the financial statement analysis technique.
Malone told Hereford to make financial statements look as if they had applied R.P .Stuart Accounting and remove the effect of one time transactions, for instance they scratched out the effect of excluding gains on investment sales for each of the last three years. This is not in conformity with analysis techniques in Accounting for movement of funds.
Malone advised the Accountant to selectively present financial statements as they are selling certain securities so as to time the recording of gains (Simko, 2004, p.3). Therefore, net income would be artificially gained, a practice contrary to GAAPs. This misleads decision makers and is in contrary to the Decision-making Accounting technique concept.
Presenting accounting information wrongly to show that the stakeholders that the organization is profitable. This violates the management reporting concept of Accounting since management decisions based on such reports are biased.
2)
Incorporate the concept of accrual based earnings management and real earnings management. List and discuss two of each.
Accrual concept of Accounting states that revenues and expenses are recorded in the books of accounts in the period in which they occur. This is irrespective of whether cash is received or not. The benefit of this method is that all expenses that fall under a certain financial year are reported the same year. Revenues are recorded when they are earned and not when they are received in cash. Application of this approach results in reporting of accurate net income, assets, liabilities and retained earnings. This improves analysis of the company’s financial performance and financial position over different periods. In the end of financial periods organizations report any accruals relating to its operations (Colin, 2006). For instance accrued expenses, adjustments of prepayments, accrued wages etc. R.P. Stuart is conservative and likes accurate reporting hence is keen on following the GAAPs in presenting financial information.
Real earning management accounting concept refers to reporting that is determined to evaluate the value of the firm through expected future firm performance based on earnings. To enhance the value of the firm it’s in the best interest of the firm to report positive earnings and growth. However hard it may be for the firm to report positive growth, firms may engage in earnings management to meet their expectations. This occurs when managers use judgment in financial reporting and structure financial statements to either mislead stakeholders or influence a contractual outcome which is depended on their reports. In the case of Malone, he advices the Accountant to adopt financial reporting concept which conceals certain financial information making the users perceive use of aggressive accounting policies by the firm, while his desire is to paint a good picture to the overall performance hence competitiveness in the stock market (Simko, 2004, p.3).
3)
Why would you be concerned with relying on Nuware’s financial performance?
Nuware’s financial statements have been presented in a manner which is contrary to the International Financial Reporting Standards (IFRS). There is overstatement of income for instance by removing the effect of one time transactions, where they scratched out the effect of excluding gains on investment sales for each of the last three years. Income recorded in the financial books of accounts does not reflect the actual business operations in the firm.
There are cases where selective reporting of stocks is used, this is done to record stocks which are more likely to yield much gains in the near future hence mislead decision makers and assume that the firm is doing well.
Accounting reporting must be comparable, it becomes hard to rely on the firm’s books of accounts because their standards are not in uniform with any other firm in the same industry and presents a ‘painted picture’ of the state of affairs in the firm.
The use of real earning approach of Accounting as adopted by Malone is not an accurate reporting practice since the underlying reasons for such policies are not universally accepted across the Accounting Boards (Everet et al, 1996).
Accounting for inventories as advised by Malone is not standard; the firm uses LIFO and FIFO methods of stock method. It becomes hard to analyze stock with two different approaches and this may result in errors in recording of inventories at a particular period. The change in the measure in which the organization measures inflation brought about a significant change in provisions. In 2001 using the old method $33 Million were recognized while in 2012, $35.1 million were recognized under LIFO provisions (Simko, 2004, p.7). This disparity is so material in such a manner that the inventory valuation method of the firm is doubtable.
4)
Restate the earnings of Nuwares and compare them to R.P. Stuart. Analyze the performance of both companies using Nuwares restated earnings. Which firm is the better performing firm?
Restatement of accounting statements refers to re-evaluation of previously reported earnings figures to incorporate new information, or new calculation methods.
On the Current assets of Nuware Inc.,
Cash is reported as $ 192,114 and includes available for sale of investments $59,716 and $ 35,076 (Simko, 2004, p.6).
Cash can be restated as,
2013 2012
Initial figure $192,114 $55609
Less $59,716 $35,076
Restated figure $132,398 $20,533
Account receivables,
2013 2012
Initial figure $295,888 $363,424
Less $9,438 $16,140
Restated figure $286,450 $347,284
Common stock,
2013 2012
Initial figures $ 10,088 $10,088
Correct figure,
In 2013,
0.1*500,000,000=50,000,000
In 2012,
0.1*100,883,000=10,088,300
Common shares in treasury at commitments and contingencies are recorded in the balance sheet as,
2013-$ 138,656
2012-$ 80,521
Based on accounting for contingencies standards, Contingencies are not supposed to be recognized in the balance sheet but are stated in the notes of financial statements.
Therefore in the notes,
Restated commitments and contingencies,
2013 2012
Contingencies and commitments (common shar...