Question

1. Explain if it is unethical for a company to keep two sets of books?

2. Discuss the argument against retaining excess cash flow.

Answer 1

1)

Yes, it is common for companies for maintaining two or more sets of books for accounting and is categorised perfectly legal or normal too. The company keeps one set of book for their financial statements which are presented to stakeholders while filing company's quarterly reports with the government as per GAAP (generally accepted accounting principles) and other set is maintained to pay their taxes to the IRS (Internal Revenue Service.

Although government's main concern is with the actual revenue and expenses; and on contrary GAAP requires company to make an estimation of both revenues and expenses all the time for internal control. Moreover for computation of depreciation expenses a company is permitted to take on its equipment may vary according to GAAP and IRS accounting rules.

2) The excess cash must be distributed or invested because excess cash can impact the company negatively in following ways:

--It increases the cost of capital of company

--It lowers the return on assets for company. Sitting on cash can be an expensive luxury as it holds an opportunity cost which may lead to the difference between the interest earned on keeping cash and price paid for having the cash as measured by the cost of capital of the company.

--It increases overall risk by destroying business value and may lead to an overly confident management team