FINANCIAL ACCOUNTING AND REPORTING IN NORTH AMERICA,Presented at School of Management, UESTC By George Lan, PhD Associate Professor of Accounting University Of Windsor Windsor, Ontario, Canada March 19, 2003,1,Outline of Presentation -1,Roles of standard setting bodies (FASB, CICA), Managers, Auditors and Suppliers of Capital (Investors and Creditors or lenders) See Diagram Information Economics Approach and Efficiency of capital markets WorldCom, Enron and Arthur Andersen Incentives of Management to Manage Earnings,2,Outline of Presentation -2,Steps to prevent scandals from occurring in the future? Some Ethical Principles An Ethical Case Questions regarding presentation or any other (accounting) questions.,3,Information Economics Approach,Information Asymmetry exists between the parties in business transactions. The managers ( agents) have more information than the investors (principals). Managers may attempt to select policies or to release biased information that benefit themselves to the expense of the owners . Role of Accounting: to provide information useful for rational decision-making.,4,Decision Usefulness Approach,Section 1000 of CICA Handbook (par. 1000.15): The objective of financial statements is to communicate information that is useful to investors, members, contributors, creditors and other usersin making their resource allocation decisions and/or assessing management stewardship.,5,Objectives of Financial Statements,Statements of Financial Accounting Concepts (1978) (SFAC 1): To provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions. To provide information to help present and potential investors and creditors in assessing the amounts , timing and uncertainty of prospective cash receipts from dividends or interest.,6,Relevance and Reliability,To be useful, accounting information should provide an informative information system that links current financial statements with future state realizations and payoffs. Accounting information should be relevant I.e. has the capacity to affect investors beliefs about future returns. Accounting information should be reliable i.e. should faithfully represents what it purports to measure. It should be precise and free from bias.,7,Elements of Financial Statements,Assets: Probable future economic benefits obtained or controlled as a result of past transactions. Liabilities: Probable future sacrifices of economic benefits Owners Equity: residual Interest in assets after deducting liabilities i.e. A= L + O.E. or O.E = A L. Revenues: inflows of assets (or settlement of liabilities) arising from the entitys major or ongoing activities.,8,Accounting Principles -1,Historical Cost Principle i.e. recognise (record and report) assets and liabilities initially at the cash-equivalent cost. Revenue Recognition Principle i.e. recognise revenues when earned (earning process is complete and an exchange has taken place ). All necessary costs have been incurred and collection is assured usually at point at sale.,9,Accounting Principles -2,Matching Principle i.e. recognise all expenses incurred in producing revenues in the same period as the revenues. Full Disclosure Principle i.e. disclose all relevant information.,10,LANS CLOTHING COMPANY,Invest 10,000 Yuans (Y) to start the business Buy 1000 shirts at 5 Y each. Pay wages of 1000 Y for the first month. Sell 400 shirts at 20 Y each. Pay rent of 600 Y for the first 6 months. Incurred miscellaneous expenses of 500 Y. Borrowed 4800 Y and bought a truck. Truck will last for 4 years. What is my net income for first month?,11,Lans ClothingNet Income for first month,Net Income before taxes = Revenues Expenses = 400 X 20 (sales)- 400 X 5(cost of shirts sold) 1000(wages expense) 600/6 (rent for one month) 500 (miscellaneous expenses) - 4800/48 (amortisation expense for 1 month) = 4,300 Yuans,12,Standard Setting revenues recognized before they are earned. Liabilities hidden from balance sheet. Gambling on energy futures contracts. Sherri Watkins ( Enron manager) blew the whistle but no one listened.,18,Arthur Andersen (Former “Big Five”Accounting Firm),Issued unqualified opinion to financial statements. Did not disclose accounting irregularities. Shredded documents to hide evidence. Guilty of obstructing justice.,19,Managements Incentives to Manage Earnings,Income taxesPostpone payment by minimizing reported income BonusMaximize their bonuses by increasing reported income Debt Agreements Easier to meet debt agreements (covenants) by increasing income and assets Stock options (give you the right to purchase a stock at a fixed price in some future period)maximize share prices (believed to be related to reported income).,20,Accruals and Earnings Management,Amortization expense Increase in net receivables Increase in inventory Decrease in accounts payable and accrual liabilities,21,What could be done?,