Question

Some of the items on the balance sheet are based on estimated information. Consider management’s responsibility when it comes to the use of estimates (e.g., net realizable value of receivables, valuation of inventories, accumulated depreciation, etc). 1.Describe the incentives management has to misrepresent estimates. 2.With the core value of integrity in mind, discuss controls and procedures companies can put in place to prevent misrepresentation of these estimates.

Answer 1

    Management is responsible to estimate various amounts in the books of accounts. The management must adhere to the accounting standards, policies and principles while making estimates in the books of accounts. The estimates must be made as per the accounting standards and policies. Proper procedures shall be followed while making estimates to ensure that ate estimates are appropriate and are I accordance with the accounting principles and policies.

Management has number of incentives for misrepresentation of estimates; these are as following:

1. To window dress the financial statements.
2. To show better financial position of an organization by estimating lower amount of depreciation, bad debts and other expenses.
3. To receive higher amount of salaries as management personnel by showing higher amount of profit than actual profits earned by the organization.
4. To divert funds of the company for the personal benefits of the management.

The company must have the following controls and procedures in place to prevent misrepresentation of estimates:

1. Necessary internal controls to ensure that all entries are recorded correctly in the books of accounts.
2. To make constant changes in employee positions. Rotation of employees will help the organization to reduce the risk of collision amongst the employees.
3. Appointing internal auditor to conduct internal audit of system and books of accounts of the company.
4. Recruiting qualified employees for different positions.
5. Concurrent audit of the books of accounts and system within the organization.
6. To keep on improving the controls within the organization.