HI6025 Accounting Theory and Current Issues Assignment Sample
Purpose of the assessment (with ULO Mapping)
This is a group assignment. Students are required to conduct research and analysis of a theoretical financial reporting issue and present their findings in a written report. Students will have to do research on relevant literature and demonstrate understanding and critical evaluation of key disclosure issues relating to the application of specific accounting standards
Weight - 40 % of the total assessments
Total Marks - 40
Word limit - 3,000 words ± 500 words
Assignment submission: Final Submission of Group Assignment: Week 10,
Wednesday, May 26th 2021, at 11:59 pm
Late submission incurs penalties of five (5) % of the assessment per calendar day unless Student Services of your campus have granted an extension and/or special consideration before the assessment deadline. Submission Guidelines All work must be submitted on Blackboard by the due date, along with a completed
The assignment must be in MS Word format, with no spacing, 12-pt Arial font and 2 cm margins on all four sides of your page with appropriate section headings and page numbers.
Reference sources must be cited in the text of the report and listed appropriately at the end in a reference list using Harvard referencing style.
Assignment Specifications for assignment help
The corporate disclosure practice will help all the stakeholders to understand and measure business operation. Annual financial statement and particularly income statement is one of the most important ones. However, a company's reported profits will be impacted by different factors, including when particular transactions and events are recognized and how such transactions and events are measured.
1) Using earning management concept, discuss why the timing of recognizing events that impact income, revenue or profit or expenses are important for managers?
"Maximum 1000 words."
ABC Ltd has incorporated a bonus plan that rewards the board of directors (executive members) by providing a bonus of 3 per cent of reported profits. This is an Accounting-based incentive that has the advantage which the accounting results may be based on subunit or divisional performance.
"A well-informed labour market will motivate management to work to maximize the value of its firm. Underperformance might lead to dismissal and, if the labour market is efficient in disseminating data, a 'failed' manager might have difficulty attracting a position with comparable pay elsewhere." (Deegan, 2020)
1) Using Positive Accounting Theory (PAT), discuss the bonus theme in general and why the bonus plan (Accounting-based) was put in place in ABC Ltd?
2) Explain whether the board of directors could be motivated to try to inflate reported profits.
3) Use the opportunistic perspective of PAT to explain the potential for managers to manipulate corporate disclosure.
"Maximum 2000 words."
Assignment Cover page clearly stating your name(s) and student number(s)
Group's Assignment Task Allocation table (except for Solo group members)
Table of Content
Body of the assignment with appropriate section headings
List of references
This report would be focused on the assessment of earning management concept using which the importance of recognizing the events that impacts revenue would be assessed. It would also discuss the bonus theme in general and why bonus plan was put in place in ABC ltd. It would further explain whether the board of directors could be motivated to inflate the reported profits. The opportunistic perspective of PAT would also be explained through this report. It would end with a conclusion summarizing the findings of the report.
Why the timing of recognising events that impact income, revenue or profit or expenses.
Earnings management is a technique used by businesses in order to produce a positive financial statement of business through assessment of financial position. Many accounting principles and rules requires the management to male decision based on the financial positioning of business. It takes advantage of the guidelines produced by businesses in order to create financial statement and inflate smooth earnings of the company (Rachmawati, 2019, pp.133-142(4)).
So, in accounting earnings management refers to the manipulation of financial statement in order to make it appear good in the eyes of investors. It is especially used by the companies in order to make the financial position appear smooth functioning. One of the most popular way to tamper the financial record is to use an accounting policy that creates short term earnings for the business.
Revenue recognition principle is an important part of the events management technique which helps in recording the timing in which the revenue of the company is generated and recognized in the financial statement of business. Theoretically, there are several times within a year in which revenue can be recognized. Technically, the earlier a revenue is recorded, the more valuable it is considered for the business (Aladwan, 2019, pp.691-707(2)).
In accounting, revenue recognition is one of the many areas that remains vulnerable to internal manipulation and bias. In fact, it has been estimated that many of accounting fraud taking place within the company arises from issues in revenue recognition, given the low amount of judgement involved in the process. Hence, it is critical for management to understand the different techniques of revenue recognition while analysing the financial statement. There are several criterions for recognizing the revenue of business some of which are as follows:
• There remains an inevitable risk of transfer an ownership reward
• The seller ultimately loses control from the managerial accounting of the sold
• The revenue amount can be effectively quantified
• The payment collection period is assured reasonably
• The incurred cost can be effectively measured (Hatane et al., pp. 196(5)).
Revenue recognition After and Before Delivery
In case of goods sales, IFRS does not allow the company to recognize the revenue until the delivery has taken place. It does allow to record the revenue after the delivery has taken place. There may be situation that makes it uncertain to determine the cost relating to future costs which in turn violates the fifth aspect of revenue recognition stated above.
For instance, if a company fails to project the future cost of the product, the above criteria would not be met. When the fifth criteria are satisfied, the company can effectively recognize the revenue. There are other reasons as well which requires the company to recognize the revenue after delivery. Once such reason includes the inability of company to reasonably estimate the amount of income and unassured collectability of accounts receivable and ownership risks with the sellers (Kaya, 2017, pp -140(2)).
Revenue Recognition for Service Provision
One is which needs special focus while determining the accounting treatment includes the contract of construction. These contracts are especially designed for asset construction or a combination of assets such as large ship and building that is usually used for several years to come. When the business is required to document revenue obtained from service, IFRS usually directs that the business must document in accordance with the rate of completion and the method of computing the completion method (Schroeder, Clark and Cathey, 2019, pp -230(7)).
Then contracts are usually of two times which are cost plus and fixed price contracts.
In case of fixed price contracts, the contractor usually agrees on paying the price before the actual beginning of construction activity. In this way, all risks are transferred to the contractor. On the other hand, in case of cost-plus contracts, the actual price depends on the hours being spent on completion of contract plus the margin of income. For businesses operating under ASPE, the completed contract method can also be used in the place. Unlike the method of completion, completed contract method would only be recognized when the contract actually is complete.
Further, the expense recognition period is another way using which the company can follow guidelines to record their financial items. As per the principle, the companies are only directly to document expense at the same time as the revenue. If this method is not followed, then expense would end up getting recognized when it is incurred which might end by being fore the actual recognition of revenue (Scott and Scott, 2015, pp -49(5)).
This principal also impacts the income tax timing. However, there are some expenses which are difficult to be related with the revenue some of which are rent, salaries and utilities. These rents are usually referred to as period cost and are generally recognized in the period in which they are incurred.
The method of expense recognition is a primary process in accrual basis of accounting which states that revenue can only be incurred when they are earned, and expenses are recognized when they are consumed. If a business practices recognizing expense during the period it pays to the supplier, then it is termed as cash basis of accounting.
So, how we can understand how the concept of timing is critical when it comes to recognizing the income and expenses. It provides a systematic approach which can be used by the business to record its financial items in the most accurate and systematic way thereby reducing the chances of incurring loss through operation and successfully gaining the confidence of the stakeholders on the performance of the business (Zhou, 2019, pp.115(2)).
Positive Accounting Theory
PAT tries to make good prediction of real-world events and translate them into accounting transaction. While other accounting theory would usually direct as to what should be done, PAT tries to evaluate and predict those transactions. PAT helps in determining as to which accounting policy must be chosen by a firm and how would it react to the newly implemented accounting standards. The overall intention of PAT theory is to determine the impact of the accounting theory that has been implemented within the company and how it differs in every firm. It recognizes that economic consequences exist. Under this system, firms usually want to ensure that they survive for the longest period of time and can effectively create long term value in the process. Firms are often seen as a collection of contracts that they have gotten into. When it comes to PAT, because firms want to be highly efficient, they would always look out for ways to reduce cost while maximizing income in the process. Hence, in this target, they would always try to adopt an accounting policy that would help in cost minimization. PAT understands that with changing market circumstance, companies also need to be flexible with their accounting standard (Suleiman, 2017, pp.1-3(1)).
With this in mind, an optimal set of accounting theory lays between contract costs and providing flexibility in times of changing circumstances. There are currently three hypotheses of Positive accounting theory.
Bonus Plan Hypothesis: Managers of firms operating with bonus plan would usually try to shift their reported earnings from future period to the current period. By doing so, they can generate more bonus for themselves.
Debt Covenant Hypothesis: The closer a firm is to breaching the accounting base covenants of debt, the higher would be the chances of managers trying to shift the reported earnings from future to current period. This is due to the fact, that by increasing the current earnings, the company is less likely to violate the rule of covenants of debts and management can then minimize their constraints in running the company.
Political Hypothesis: The higher the cost faced by the firm, the more likely would be the manager in choosing an accounting process that would shift the earning revenue from current to future period. Further, high profitability can often lead to political conflict within the country, and which can lead to higher tax payments (Ward and James, 2015, p.143(2)).
Bonus is the pay that the company pays to its employees in addition to the base salary. This strategy is used by several organization as a way to acknowledge the hard work and dedication of the employees and their contribution to the company. It is also used to boost the morale of employees. When a company attaches bonus with the base pay of employee, it encourages them to work harder to reach its objectives and ensure that the business is taking all the right action in order to reach objectives and take the company to new heights of success. There are several benefits of paying bonus to the employee some of which are as follows:
• Boosting morale of employees
• Making the workforce reach objectives within a specified deadline.
• Enabling the company to increase their chances of generating higher revenue
• Reducing staff turnover rate (Roden, Cox and Kim, 2016, pp.80 (3)).
• Ensuring maximum work satisfaction.
As can be noted from the task case study in the assignment, ABC limited has adopted a bonus strategy as per which all the board of directors would be paid within 3% of the reported profit.
The general question that should arise here is whether a bonus plan is really that effective in encouraging the employees to work hard within the company. The straight answer to this question would be when the company makes the right investment strategy, it automatically leads to healthy working environment, which in turn enables the firm to generate higher income for the future. Recent studies have shown that companies working with bonus has higher chances of success compared to those without any effective bonus plan in place (Ausloos, Cerqueti and Mir, 2017, pp.238(6)).
So, based on these assumptions, ABC ltd have adopted the strategy in order to ensure that the directors are working productively and are able to generate significant wealth over time which can be utilized by the company in order to expand brand image and ensure that the company is following a strict protocol. In order to understand the efficiency of a bonus system it is critical that the business is able to compare the performance of the firm with the time it did not have any effective bonus strategy in place.
There are several advantages of having a bonus plan in place and hence ABC ltd is encourage to utilize the strategy in the upcoming years as well (Lin, 2016, p.1253(1)).
Can Board of Director inflate the Revenue
Earning manipulation is easy when directors hold too much power over the business. In order to increase bonus payment, directors would want to inflate the net income of the business. Additionally, the net income would also be boosted when they want to attract higher stakeholders within the business. These inflated earnings would make the business look more profitable while in reality the picture would be much different. First, let’s analyses the ways in which board can inflate the earnings of business:
• Accruing fictitious income from year-to-year income.
• Documenting the sales of the products that have not been shipped.
• Selling the product at inflated price to related parties
• Documenting the revenue in present year that would be generated in the next year.
• Documenting shipments to resellers that are not profitable and hence not a viable income option.
• Accruing projected sales that have not really taken place (Shakeel and Srivastava., pp.110(2)0.
• Intentionally tampering with allowance of receivables.
In an attempt to boost the bonus, pay, board of director can take several measures including:
• Playing around with Expenses: Board would deliberately try to high the expenses in order to inflate the income of the business or
• When they record the expenses in the income statement, they would try to convince to the readers, that even though they have incurred expense, but it would not impact the overall profit of business (Yisha, 2020, pp.125 (8)).
• There are often instances where the board of director have shown profit in the business when they are actually incurring huge amount of loss. In some cases, companies reflect profit when they are generating no profit. In some cases, investors have shown profit on investment even when investors cannot make any sense of that profit. In some cases, companies reflected profit in P/L but were able to convince that even when there are losses, the income statement does not get affected.
• In some cases, directors have also chosen the way of reflecting loss at the last resort when there is no option left.
• They can also not spend on areas that needs immediate attention in order to preserve the capital and inflate the performance of business in return.
• They also change accounting profit whenever necessary in order to inflate the income of business (Sa Vinhas and Heide, 2015, pp.165(2)).
The directors cannot inflate the profit of business in order to suit their best interest and ensure that the company is generating significant amount of profit. Directors can manipulate the data only when they have their best interest in mind and when they hold significant decision-making power over the business. Additionally, the income of the business cannot be manipulated by directors unless stated by the owner of the company or when it is done in the best interest of the company. If under any circumstance, the business fails to identify the manipulation taking place within the organization, it would then have to take legal action against such practices
This is a major disadvantage of having bonus attached to the business. The business would also need to ensure that the company is free from such practices in order to generate maximum benefit and produce reliable result which can be used to generate wealth overtime. The company would also need to understand how these manipulations can harm the brand value in the long run. So, even though bonus is a great way to improve efficiency, it can also result in increased manipulation of data in order to get higher bonus and in turn the directors would try to show inflated profit in the financial statement even in reality the performance is much different. Hence, directors are never given the power to change the statement of the financial statement and work in their best interest (Coutinho, Sancovschi and dos Santos, 2019, pp.250-381(3)).
Use the opportunistic perspective of PAT
The opportunities perspective suggests that when a manager works for a business, he would always have his best interest in mind and would therefore try to manipulate data in a way that would increase his gain in the process. They only adopt accounting policies that allow them to maximize their gains when the firm also gains. There are different types of hypothesis in existence such as bonus plan, political cots and debt hypothesis that show motives makes manager choose an accounting method over another (Yisha, 2020, pp.271(5)).
There are several ways in which the manager can manipulate the data of business. One major reason that leads to manipulation is the increased conflict between the accounting firm and the audit them. Manipulation would always involve steps that would make the manager takes steps that would go against the wish of the company. This in turn would impact the brand value and in turn would also make the company vulnerable to market risk.
Discussed below are some ways in which the accounting data is manipulated by managers to suit their best interest.
• Recording the revenue before suppling the goods and services to the customers.
• Reporting income from investment while using that income to cover for the loan.
• Capitalizing the business expenses, thus shifting them from income statement to the balance sheet (Rachmawati, 2019, pp.133-142(1)).
• Inaccurately reporting the liability or neglecting them all together.
Most common way of manipulating the data is by inflating the value of asset with false count. For instance, a company may have ordinary account of inventory but add 100 items to each count. Hence, investors are advised to cushion themselves from such fraudulence activity and would protect the company from bias. The best way to protect against such manipulation would be to obtain effective financial education. The investors must understand how to read and interpret three aspects of financial statement including income statement, cash flow statement and balance sheet of the company. The company would also need to continue using the company to come up with effective strategy that would prevent its employees from manipulating the data and ensuring that the business is always moving forward in the right direction. Also, it is critical to understand that managers would commit to suit their best interest in the company and would only be productive if only it has some selfish motive attached with it. It would also ensure that the company would be using the company’s financial report in order to come up with the most reliable report which can be used to make investment decision (Aladwan, 2019, pp.691-707(2)).
Financial statement can never be fully protected from manipulation and hence there are effective legal action in place to effectively punish the companies taking part in such practices and putting the reputation of brand at stakes. The company would also need to understand that the manipulation of financial statement is an inevitable part of financial statement and hence the owners need to be more more careful while making decision. This is a major reason why companies choose to get their financial statement prepared by third party auditors who do not only ensure lowest possible error but also increases the reliability on the operations (Hatane et al., pp. 197(3)).
To conclude, earning management is a tool which companies uses to manipulate the data of company to make it look more appealing to the investors. The investors become victim of false information and can incur huge loss as the managers of business work on their best interest and thinking about shareholder’s wealth maximization becomes their last priority. Further, the bonus hypnosis indicates that the managers would always try to shift future revenue to current period in order to generate higher revenue.
Aladwan, M., (2019). Accrual Based and Real Earning Management Association with Dividends Policy “The Case of Jordan”. Italian Journal of Pure and Applied Mathematics, pp.691-707.
Ausloos, M., Cerqueti, R. and Mir, T.A., (2017). Data science for assessing possible tax income manipulation: The case of Italy. Chaos, Solitons & Fractals, 104, pp.238-256.
Coutinho, A.H., Sancovschi, M. and dos Santos, A.G.C., 2019. The opportunistic approach of the Positive Accounting Theory (PAT) fails to explain choices made at OGX: An anomalous situation? Revista de Contabilidade e Organizações, 13, pp. e164412-e164412.
Hatane, S.E., Pranoto, A.N., Tarigan, J., Susilo, J.A. and Christianto, A.J., (2021). The CSR Performance and Earning Management Practice on the Market Value of Conventional Banks in Indonesia. In Global Challenges and Strategic Disruptors in Asian Businesses and Economies (pp. 196-213). IGI Global.
Kaya, ?., (2017). Accounting choices in corporate financial reporting: A literature review of positive accounting theory. Accounting and Corporate Reporting-Today and Tomorrow.
Lin, T.C., (2016). The new market manipulation. Emory LJ, 66, p.1253.
Rachmawati, S., 2019. Company Size Moderates the Effect of Real Earning Management and Accrual Earning Management on Value Relevance. Ethics: Journal of Economics, 18(1), pp.133-142.
Roden, D.M., Cox, S.R. and Kim, J.Y., (2016). The fraud triangle as a predictor of corporate fraud. Academy of Accounting and Financial Studies Journal, 20(1), p.80.
Sa Vinhas, A. and Heide, J.B., (2015). Forms of competition and outcomes in dual distribution channels: The distributor’s perspective. Marketing Science, 34(1), pp.160-175.
Schroeder, R.G., Clark, M.W. and Cathey, J.M., (2019). Financial accounting theory and analysis: text and cases. John Wiley & Sons.
Scott, W.R. and Scott, W.R., (2015). Financial accounting theory. Pearson Canada Inc.
Shakeel, M. and Srivastava, B., A Study on High-Frequency Financial Data Manipulation and Visualisation.
Suleiman, S., (2017). Debt Contracting and Conditional Accounting Conservatism. International Journal of Accounting Research, 5(1), pp.1-3.
Ward, T.J. and James, K.L., (2015). Student participation and performance in a graduate accounting theory class. Academy of Educational Leadership Journal, 19(2), p.143.
Yisha, M., 2020. Analysis on Efficiency and Opportunistic Perspective under the Pat. The Frontiers of Society, Science and Technology, 2(17).
Zhou, Y., 2019. A Concept Tree of Accounting Theory:(Re) Design for the Curriculum Development. Education Sciences, 9(2), p.111.