Albrecht Ch 5 SM 2PP.docx
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Albrecht Ch 5 SM 2PP.docx
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AlbrechtCh5SM2PP
CHAPTER5
DISCUSSIONQUESTIONS
1.Ifajournalentryisforalegitimateexpense,therewillbeanauthenticdocument(e.g.,abillorinvoice)fromwhoeverwaspaid.Ifitistocoverupatheftofcash,either
(1)therewillbenosourcedocumenttosupporttheentryor
(2)therewillbeafictitiousorforgeddocumentsupportingtheentry.
2.Revenuesareusuallyoverstatedbycreatingfictitiousreceivablesorbymakinganerrorthatoverstatesreceivables.Whenareceivableisdebited,arevenueiscreated.Totalassetswillbeoverstatedifrevenuesareoverstated.
3.TheForeignCorruptPracticesActisanamendmenttothesecuritieslawsthatwaspassedbyCongressin1977.Itisimportanttofinancialreportingbecauseitrequirescompaniestomaintainasystemofinternalcontrolsthatprovideintegrityinfinancialstatements.
4.Therearefiveelementsofasystemofinternalcontrols.Mostimportanttoaccountantsarethe
(1)controlenvironmentand
(2)controlprocedures.
5.Fivedifferenttypesofcontrolproceduresare
(1)segregationofduties,
(2)systemofauthorization,(3)documentsandrecords,(4)physicalsafeguards,and(5)independentchecks.
6.Thefourfactorsthatoftenmotivatemanagerstoattempttomanageearningsare
(1)tomeetinternaltargets,
(2)tomeetexternalexpectations,(3)tosmoothincome,and(4)windowdressingforanIPOoraloan.
7.a.Thepurposeofinternalearningstargetsistomotivatemanagersandemployeestoincreasetheireffortsinproducingsalesandcuttingcosts.
b.Theriskwithinternaltargetsisthatpressuretomeetthetargetsmaycauseemployeestomakedecisionsthatarenotinthecompany’sbestinterest.
8.Theterm“incomesmoothing”referstoafirmmanagingitsincometopresentastable,steadyincreaseinincomeratherthanavolatileearningspattern.Financialstatementuserspreferasteadyearningspattern.
9.Savvytransactiontiming—Timingtransactionstoensurethatanygainsorlossesaredisclosedintheperiodwhichmostfavorsthecompany.
Aggressiveaccounting—Changingaccountingmethodsoraccountingestimatesandfullydisclosingthosechangesinthenotestothefinancialstatements.
Deceptiveaccounting—Changingaccountingmethodsoraccountingestimateswithoutdisclosingthechangesinthenotestothefinancialstatements.
Fraudulentreporting—UsingaccountingmethodsthatarenotacceptablealternativesaccordingtoGAAP.
Fraud—Fabricatingtransactionsorknowinglyrecordingtransactionsincorrectly.
10.Changingaccountingestimatesfromoneyeartothenextisacceptableaslongasthechangeisfullydisclosedinthenotestothefinancialstatements.
11.a.PointEisoutsidetheGAAPovalandwouldinvolvetheuseofunacceptableaccountingalternativestoachieve.PointCresultsinanearningsfigurethroughtheuseofacceptableGAAPmethods.
b.PointsAandCdifferinthatwhilebothresultfromtheproperapplicationofacceptableGAAPalternatives,pointCinvolvestheuseofaccountingmethodsthatresultinthehighestearningsfigurewhilepointAinvolvestheuseofmethodsthatresultinthelowestacceptableearningsfigure.BothpointAandpointC’searningsfiguresinvolvetheuseofacceptableaccountingmethods.
12.ThePublicCompanyAccountingOversightBoardischargedwithregisteringallpublicaccountingfirmsthatprovideauditsforpubliccompanies,establishingstandardsrelatingtotheauditofthosepubliccompanies,investigatinganddiscipliningauditingfirmswhennecessary,andenforcingcompliancewiththeSarbanes-OxleyAct.
13.Auditorsarenotallowedtoprovidecertainnon-auditservicesforthosecompaniesthattheyaudit.Inaddition,auditpartnersarerequiredtorotateoffanaccounteveryfiveyears.
14.TheSarbanes-OxleyActprohibitscompaniesfrommakingloanstotheirexecutiveofficersanddirectors.
15.Amongotheractivities,internalauditorsindependentlyevaluatetheinternalcontrolsofanorganization.Oneofthepurposesofinternalauditorsistoprovideintegrityinfinancialreporting.Thus,byenhancingtheinternalcontrols,thecredibilityoffinancialstatementsisincreased.
16.Thepurposeofafinancialstatementauditistohaveindependent,outside,competentindividuals(CPAs)renderanopiniononwhetherfinancialstatementsarepreparedinaccordancewithGAAPandarefairlypresented.Theiropinionaddscredibilitytothefinancialstatements.
17.WhetherCPAscanbeindependentfromthecompaniesthattheybothauditandreceivepaymentfromisanissuethathaslongbeendebated.Ontheonehand,criticscannot
pointtoverymanycaseswheretherewasatruelackofindependencethatcausedproblems.Ontheotherhand,thereisagrowingfeelingthatlackofindependenceisaproblem.Recently,attheurgingoftheSEC,anIndependenceStandardsBoardwasorganizedtodealwiththisissue.
18.Thereisreallynocomparison.Becauseinitialfilingsareusedtoraisemoney,theyarescrutinizedmuchmorecarefullythanaretheperiodicreports.However,bothtypesofreports(exceptforthequarterlyfilings)mustbeaccompaniedbyaCPA’sauditopinion.
19.TheFASBistheprivate-sectorrule-makingbodyinaccounting.TheSECisthegovernmentalagencywiththeauthoritytoregulatethefinancialmarkets;setrules;monitorthepublictradingofsecurities,thefinancialstatements,andotherdisclosuresofpubliccompanies;andsanctioncompaniesthatviolateSECrules.TheSECissuesaccountingstandardswhentheFASBhasnotactedinanareathatitdeemstobeimportant.Forthemostpart,theSECacceptsFASBstandardsasbeingtheauthoritativeguidelinesforfinancialstatements.Therelationshiphasbeenoneofmutualrespectandcooperation.
EXERCISES
E5–1(LO1)AccountingErrors—TransactionErrors
a.Theassetaccount,Equipment—Truck,isunderstatedbythecostofthetruck.MaintenanceExpenseisoverstatedbythesameamount.Inthebasicaccountingequation,AssetsandOwners’Equityareeachunderstated.Theoverstatedexpenseresultsinanunderstatementofincome.
b.CashisunderstatedandAccountsReceivableisoverstated.Theaccountingequationisnotaffectedbecausebothaccountsareassets.Becausenorevenueorexpenseaccountsareaffected,incomeisnotaffected.
c.AccountsReceivableisoverstatedbytheamountofthefictitioussales.SalesRevenueisalsooverstatedbythesameamount.Intheaccountingequation,AssetsandOwners’Equityarebothoverstated.Becausetherevenueaccountisoverstated,soisincome.
d.BothRepairsExpenseandAccountsPayableareunderstatedby$300.Intheaccountingequation,LiabilitiesareunderstatedandOwners’Equityisoverstated.Incomeisoverstatedby$300becauseoftheexpenseunderstatement.
e.UnearnedRevenue,aliabilityaccount,isunderstatedbytheamountoftheprepaymentreceivedonDecember31.RentRevenueisoverstated.Intheaccountingequation,LiabilitiesareunderstatedandOwners’Equityisoverstated.Incomeisoverstatedbecauseoftherevenueoverstatement.
E5–2(LO1)ErrorsinFinancialStatements
BalanceSheet
Assets
Cash$1,300
Realestateproperties(previouslylisted)6,000,000
Propertyrecordedassold*1,800,000
Totalassets$7,801,300
Liabilities
Accountspayable$100,000
Mortgagepayable6,000,000
Totalliabilities$6,100,000
Stockholders’Equity
Capitalstock$10,000
Retainedearnings1,691,300
($5,071,300–$3,380,000)
Totalstockholders’equity$1,701,300
Totalliabilitiesandstockholders’equity$7,801,300
*$5,000,000(salesprice)–$3,200,000(gainonsale)=$1,800,000(propertyvalue)
IncomeStatement
Revenues$0
Expenses1,200,000
Netloss$(1,200,000)
Note:
Thisisarealcasewheremassivefraudwascommitted.
E5–3(LO1,LO3)AppropriatenessofAccountingRules
Whilemanypeoplewouldquestionwhethertheaccountingisappropriate,thetreatmentinthiscasecanactuallybejustifiedbyGAAP,becausethereisareadymarketfortherefinedproductsandboththesellingpricesandthecostofrefiningtheoilcanbereasonablyquantifiedordetermined.Thisisagoodcasetohavestudentsdebateandexperiencetheimprecisenessofaccountingrules.Inthiscase,expertsfortheplaintiffsarguedthatthetreatmentwasinappropriate,whileexpertsforthedefensearguedthatthetreatmentwasappropriate.Therearemanyexamplesconcerningrevenuerecognition,inventory,andotherissueswheretheproperaccountingtreatmentisnotabsolutelydetermined.Theseexamplescanbeusedtoshowstudentsthataccountingisnotanexactscience.
E5–4(LO2)InternalControlProcedures
a.Authorization.Themanagersofthestoresshouldfollowtheauthorizationpolicyandreviewallrequestsforlargeamountsofcredit.
b.Segregationofdutiesandindependentchecksonperformance.Thebankreconciliationshouldbeperformedbyasecondindividual,preferablysomeonenotintheaccountingdepartment.
c.Segregationofduties.Variousfunctionsshouldbeassignedtodifferentpeople.Iftherecordkeepingandphysicalhandlingofinventorywereperformedbytwoseparateindividuals,theopportunityfortheftwouldbegreatlyreduced.
d.Adequatedocumentsandrecords.Awell-designeddocumentshouldbeformattedsothatitcanbehandledquicklyandefficiently.
E5–5(LO5)InternalAuditing—StaffingInternalAudits
Internalauditorsshouldnotbeassignedtoaudittheactivitiestheyhavepreviouslyperformed.Internalauditorsshouldbeabletouseprofessionaljudgmentandobjectivityintheirwork.Therefore,assignmentsshouldbemadetoavoidpotentialconflictsofinterest.Thestandardsforinternalauditingstatethatsituationsliketheoneinthisexercisearepresumedtoimpairobject
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