Question

1. We have discussed several accounting issues, aspects of the financial statements, etc throughout the semester. As non-accounting majors, the overwhelming majority of you will likely not strive to become CPAs, but rather would use financial statements to make decisions for a variety of purposes.

One use of the financial statements is to derive metrics to indicate entity financial health, efficiency, profitability, etc. Identify five different or separate examples of these metrics and describe how inappropriate accounting treatment can lead to inaccurate misrepresentation of this metric. The inappropriateness you describe can be unintentional (i.e. due to error) or intentional (i.e. due to fraud). Be as specific as possible in your responses. For example, your response should extend way beyond something like this:

Ratio #1 is calculated by A divided by B. The ratio will go up if either A is higher than it should be or B is lower than it should be. Of course that will be the case; that it just basic arithmetic. WHY was any component misrepresented: what GAAP was not followed, what misjudgments were made, what was misclassified, etc. are the bigger issues here. It’s also more than merely not recording something.

By different I mean 5 different metrics and 5 different accounts. Please do not use a single metric and state five things that can affect it. In addition, do not show how the same account misrepresentation can affect 5 different metrics in a relatively similar way.

Answer 1

1. Mistake in computation of depreciation can lead to misrepresentation of cash flow from investing activities by indirect method e.g- If Depreciation is lesser than less amount shall be adjusted with purchase of assets leading to cash flow from investing reflecting higher outflow for purchases. Further, IFRS requires that depreciation should computed consistently using estimated useful life. Error could occur due to manual computation error or wrong useful life used.

2. Deferred tax not created on temporary differences could lead to lower/higher Earnings Per Share. IFRS requires that Deferred tax asset/liability should created on all the deductible temporary differences.

3. Cash held in deposit and deposit is in lien disclosed as Cash and cash equivalent could affect liquidity ratio. IFRS defines cash and cash equivalent as cash, bank balances and deposits with originial maturity less than 3 months but not under lien.

4. Goodwill not impaired due to error leading to higher EBIT. IFRS requires that an entity shall assess the Goodwill for each cash generating unit for impairment on annual basis.

5. Wrong computation of non controlling interest could represent higher/lower book value per share. IFRS requires that Non Controlling Interest should be estimated at fair value.