Question

1. Describe the reasons a naïve observer would consider it overkill to scrutinize a company’s financial statements for signs that management is presenting anything less than a candid picture?

2. How does that method of accounting for a merger or acquisition affect the combined companies’ subsequent competitive strength, ability to generate cash, or reported earnings; and what are the clues that there may be something amiss in an M&A?

3. a) Explain the tension that exists for the auditing firm? (b) What can be said about the existing provisions for issuing financial accounting standards?

Answer 1

Answer 1: Following reasons can be ruled out

• There are already present laws and regulations which makes it mandatory for publicly listed companies to disclose all the material events affecting the value of their securities in any manner. This makes sure that if there's something which requires the attention of investor will be disclosed appropriately.
• All the firms are required to be annually certified by highly competent auditors where all the auditing standards will be followed.
• Besides all the laws and regulations, there are government agencies such as SEC's Finance and Enforcement Division which will keep an eye on any irregular activities.

Answer 2:

Choosing a method of accounting for a merger or an acquisition will not affect the companies' subsequent competitive strength or its ability to generate cash. Both the things are not dependent in any manner on a method of accounting chosen.

However, the reported earnings might get affected adversely if any wrong method of accounting chosen. As all the investors rely on the reported earnings, it might put the company in a bad picture before investors and other stakeholders where it is not so bad in reality.

Following can be such clues:

• Price discount - Generally, there are rigorous negotiations between parties before M&A. However, price discounts are generally seen as hints for something wrong.
• Regulatory Inconsistencies - this includes irregular compliances by the company.

Answer 3:

A) The tension that generally exists within an audit firm is maintaining a client and professional standards while executing audits. They have a fear of losing clients if they don't do the work as required by them.