In: Accounting
1. Generally accepted accounting principles refer to the U.S. guidelines and procedures that accountants or others required to present financial information follow. These include specific principles regarding the presentation and disclosure of certain financial activities, such as revenue recognition and continuity of asset values. The U.S. government requires that publicly traded companies follow GAAP.
Significance
GAAP guidelines help businesses maintain consistency in their presentation of financial information, reduce the risk of misrepresentation and avoid fraud. GAAP was created to safeguard the rights of stakeholders, including investors. It holds companies responsible for their financial reporting activities, thus providing greater assurance to all interested parties. Through the use of GAAP guidelines, companies provide true and fair presentation of financial information.
Consistency
Adhering to GAAP guidelines can help you implement proper controls and safeguards. The fact that the GAAP guidelines suggest using a consistent basis that professionals can apply to accounting transactions illustrates this fact. Consistency leads to a more fair presentation and helps in comparing financial statements across multiple periods. This helps you determine your company’s overall performance, identify areas that need improvement and judge the benefits of changes that you implement.
Stakeholder's Trust
Presenting your information using GAAP also helps to instill trust in those with an interest in your company. There are many possible ways to manipulate the financial information of a company, and many times, a simple modification to the way things are presented changes the face of financial statements. These changes can cause the reader to interpret the statements differently than if the modifications were not applied. Complying with GAAP guidelines gives assurance to anyone interested in your company that your financial statements were prepared using standard guidelines.
Comparable Statements
Investors and other interested parties can compare financial information of across different companies because GAAP provides standardized guidelines that accounting, auditing and financial professionals follow. This means that you can draw realistic conclusions about your company’s performance, as the accounting principles that you use are consistent with those of your competitors. If GAAP guidelines were not applied, a high profit shown by one company might not be comparable to a company showing lesser returns because of a difference in the revenue-recognition method. One company might have higher profits than another in true terms; however, the lack of standardization makes comparing the two results difficult.
disadvantages
•GAAP accounting provides management with a lot of tools in presenting the companies financial position. Such treatments for depreciation, deferred taxes, and amortization for R&D to name a few can be altered to present a smoothed picture of a company. The reality is companies do not operate this way. They are subject to the whims and flows of changing consumer demand, external economic fundamentals, constraints in managing their scarce capital.
•As a result GAAP accounting is limited in that doesn’t necessarily present the economic reality the company is operating.
• GAAP accounting nudges companies to prepare financial statements that appeal to creditors rather than shareholders. For equity investors, GAAP accounting provides a manipulated and not necessarily accurate snapshot of the companies financial position and performance
2. Membership in the American Institute of Certified Public Accountants is voluntary. By accepting membership, a certified public accountant assumes an obligation of self-discipline above and beyond the requirements of laws and regulations. These Principles of the Code of Professional Conduct of the American Institute of Certified Public Accountants express the profession's recognition of its responsibilities to the public, to clients, and to colleagues. They guide members in the performance of their professional responsibilities and express the basic tenets of ethical and professional conduct. The Principles call for an unswerving commitment to honorable behavior, even at the sacrifice of personal advantage.
3. CPAs are licensed and regulated by their state boards of accountancy. Additionally, all AICPA members are required to follow a rigorous Code of Professional Conduct which requires that they act with integrity, objectivity, due care, competence, fully disclose any conflicts of interest (and obtain client consent if a conflict exists), maintain client confidentiality, disclose to the client any commission or referral fees, and serve the public interest when providing financial services. The vast majority of state boards of accountancy have adopted the AICPA Code of Professional Conduct within their state accountancy laws or have created their own.
6.
Responsibilities
"In carrying out their responsibilities as professionals, members should exercise sensitive professional and moral judgments in all their activities."
This principle directs accountants to work collaboratively with other accountants to improve both the image and practices of accounting. Part of that responsibility includes public education, helping both clients and the general public understand the role, standards and limitations of accountants.
The Public Interest
"Members should accept the obligation to act in a way that will serve the public interest, honor the public trust and demonstrate commitment to professionalism."
Rather than advocating for one segment of what constitutes accounting's public -- clients and employers, creditors, governments, investors, and the business and financial community at large -- accountants must strive to represent the collective well-being of all those parties. Bottom line: When the overall public good is served by employing all of accounting's guiding principles, the best interests of an accountant's client or employer get served in the process.
Integrity
"To maintain and broaden public confidence, members should perform all professional responsibilities with the highest sense of integrity."
It's easy enough to say accountants shouldn't stick phony numbers in a balance sheet. More to the point, accountants also need to avoid even subtle misrepresentations, including misstatements by omission or by ignoring obtainable information, in carrying out their duties. An accountant should never stop short of obtaining all sufficient data to provide a reasonable foundation for his conclusions or recommendations.
Objectivity and Independence
"A member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attestation services."
Independence governs an accountant's ability to work with integrity and objectivity. Independence also is highly subjective. Although an accountant may demonstrate independence in appearance, acting independently in fact requires an accountant to be free of even potential conflict, both in action and in mental attitude, a particularly immeasurable standard. The institute suggests a pragmatic approach in dealing with independence, allowing an accountant to footnote a job report disclosing possible -- even potentially implied -- lapses in independence.
Due Care
"A member should observe the profession's technical and ethical standards, strive continually to improve competence and the quality of services, and discharge professional responsibility to the best of the member's ability."
This principle exhorts accountants to regularly pursue continuing education, especially regarding generally accepted practices in the profession. It also expands the definition of responsible and ethical work to include offering service only in the accountant's area of competence and within her level of expertise.
Scope and Nature of Services
"A member in public practice should observe the Principles of the Code of Professional Conduct in determining the scope and nature of services to be provided."
To forestall problems arising during the performance of a job, this principle encourages accountants to accept jobs only from clients willing to work within the technical, ethical and professional standards included in the guiding principles.
8.
A big bath is an accounting term that is defined by a company's management team knowingly manipulating its income statement to make poor results look even worse in order to make future results appear better. It is often implemented in a relatively bad year so that a company can enhance the next year's earnings in an artificial manner.
How Firms Can missuse a Big Bath-
If a CEO concludes the minimum earnings targets cannot be made in a given year, he has an incentive to move earnings from the present to the future because the CEO's compensation does not change regardless if he misses the targets by a little or a lot.
The CEO can shift profits forward in several ways: by prepaying expenses, taking write-offs, or delaying the realization of revenues. By taking on these measures in a big bath maneuver, the CEO increases the chances of getting a large bonus the following year. Prepaying expenses and taking write-offs are particularly useful in a big bath scenario.
Banks can also engage in a big bath. Banks typically face rising delinquency and default rates on loans when the economy goes into recession and unemployment rises. These banks often write off the loans beforehand in anticipation of the losses and create a loan loss reserve. A bank can effectively create a big bath and be liberal with the loan loss provision as its earnings are hurt by tough economic times.
When the economy recovers and loan payments are paid on time and in greater numbers, the bank can reverse the losses in the loan loss reserve that were not realized and boost earnings in future quarters. Management can benefit from higher compensation, and the bank's share price can recover from a fall during tough financial times.
15. The Advantages of Using Contingency Fees-
Contingency fee arrangements have several advantages for clients:
The Disadvantages of Using Contingency Fees-
Of course, as with anything, there are certain disadvantages to contingency fees, as well. A contingency fee arrangement could potentially cost you more than a regular hourly fee. Once you agree on the contingency fee, you owe the agreed upon percentage no matter how long the case will take–whether it takes a year or a week. This is especially true in clear-cut cases that may only require a few phone calls and a couple of hours of work in order to settle. Make sure you discuss your options with your attorney before you make a decision. Some attorneys may offer a flexible contingency fee depending on the outcome of your case.
When attorneys take cases on a contingency basis, they may be more selective about the cases they agree to take on. They may try to avoid cases that they don’t see as easy victories, or may negotiate higher fees for “riskier” cases.
19.
Cookie jar accounting or cookie jar reserves is an accounting practice in which a company takes a quantity of large reserves from an economically successful year and incurs them against losses from less successful years. Through this process, companies can mislead investors into believing that their losses are less than the actual value.
An example of a cookie jar reserve is a liability created when a company records an expense that is not directly linked to a specific accounting period—the expense may fall in one period or another. Companies may record such discretionary expense when profits are high because they can afford to take the hit to income. When profits are low, the company reduces the liability (the reserve) rather than recording an expense in the lean year.
20.
The Enron scandal provides a fascinating case study on corporate governance and board room management.
One of the best reasons to study history is to avoid making mistakes that have already occurred in the past.
Five actionable lessons that investors can take away from this unfortunate bankruptcy are: