ECON3411 Contemporary Issues in Accounting

Part 1

Literature review

In a perfect world, executives, investors and board members will have complete faith in organisations’ financial statements. According to Young(2013), stakeholders could depend on the figures to make diligent projections of the timing, scale and uncertainty of future cash flows and to determine whether the consequent projection of value was represented fairly in the prevailing stock price.. Firstly, financial statements depend on judgment calls and projections which could be broadly off the mark, even when prepared in good faith. Secondly, Executives and managers regularly face strong incentives of intentionally introducing errors into the financial statements. The present essay delves deeper into how multinational companies detect such manipulation through the technique of revenue recognition and the preventive measures used by them.

Several studies undertaken over the years have identified that ineffective revenue recognition has been the most commonplace vehicle for financial reporting fraud. Study of Caylor (2010) shows that the theoretical framework available for limiting the financial manipulation and strengthening of research in accounting and finance is derived from the people who are affected and misled the maximum by their use and also for them who wish to make their business safer. The main initiators of the preventive policies are legal and regulatory bodies like ISA. However, it must be noted that the biggest effort against misleading of accounting information should be first initiated by the company as if the financial statements do not represent its reality, the company’s safety is affected to a great extent.

Theoretical frameworks that underpin research in accounting and finance

The absolute responsibility in the public company for the quality of financial reports in the existing financial reporting supply chain is placed on the Board of directors and internal officers. If there is any occurrence of fraud in the financial statements, then the internal officers are characterised by alack of integrity. In accordance with the viewpoint of Cetinand et.al. (2016), with the adoption of accrual-based accounting and International Financial Reporting Standards by many companies has minimised the chances of fraud but has not eliminated them (Cetin, Demirçiftçi&Bilgihan, 2016).

                               

Figure 1: Graphical representation of the theoretical framework of existing financial reporting system

(Source: Libby and Emmett, 2014)

Alternative Research Methodologies

Due to the ineffectiveness of controls and the possibility of the management for overriding controls, there is a need for additional analytical procedures. This alternative methodology calls for continuous research for devising towards alternative ways of identifying the fraud. Study of Gilliam(2014) shows that on the basis of the above logic, a model is proposed by the regulatory authorities wherein the shareholders would employ independent public accountants or relative firms that would be responsible for collecting data independently and preparing accounting report. According to Rahman, Moniruzzaman and Sharif,(2013) the reports prepared by management are then compared with those prepared by these accountants, and both are then be subjected to evaluation third party audit. Although these methods would mean additional expenditures but these expenses would be far less than the scam.

With regards to the third party of the company- auditors, they must strengthen their efforts to address the possible exploitation of information furnished in the financial statements. Härkönen (2017) stated that for this purpose, the audit function includes an evaluation of internal control system of the company for the prevention of creative accounting.

                                       

Figure 2: The Alternative Approach of Research in Finance and Accounting

(Source: Ikechukwu, 2013)

Various Methods Adopted by Multinational Firms

Analysis of various methods adopted by Multinational Firms and the manner in which same assist in detection and reduction of manipulation of revenue:

Sales-based Method- Under this method, the revenue is recognised at the moment when the title of the goods or services is transferred to the consumer, that is, the time when the actual sale takes place, irrespective of the type of transaction, i.e., cash or credit (Piper, 2016). According to Rahman, Moniruzzaman and Sharif,(2013) the reports of sales prepared by management are then compared with those prepared by these accountants, and both are then be subjected to evaluation third party audit. Although these methods would mean additional expenditures but these expenses would be far less than the scam.

Percentage Completion Method – this method is used in companies dealing with construction and engineering. These companies require many years to transfer the ownership of products, in this case, the infrastructure, to their customers. According to Weiss(2014), with the sales based method, a large amount will be stuck on a particular project. Hence, these companies are eligible for percentage completion method. By following this method, the company can address their revenues in between the project and present the same to their shareholders. As per the viewpoint of Sharma and Panigrahi (2013) this method can be used only when their entities enter into a long-term contract with their customers, and the completed percentage of the project can easily be estimated. The existing frameworks for accounting policies strengthen the responsibility of corporate officers for the accuracy and reliability of accounting statements. There are established criminal penalties for an untrue certification which is intentional. The executives involved in fraudulent reporting are barred off their bonuses and profits (Tassadaq and Malik ,2015).

As per this method, the entity can either use the milestone method of estimating the completed project, like the number of milestones built or left ((Dutta, 2013).  Another criterion for estimating the percentage completed is the cost incurred in which the estimated cost is compared to the budgeted cost (Weiss, 2014).

Instalment method- this technique is used if there is inconsistency in the customer collection such as in cases of real estate business where the payments are made by the customer in unfixed intervals. In these companies, the sale is agreed, but the payment is highly subjected to the availability of finance for the customers (Rahman, Moniruzzamanand Sharif, 2013). The application of this method assisted in evaluating actual profit and also in improving the base used for estimating figures. As a result, the profit for an accounting period is only recognised when there is actual receipt of payment. Thus, due to same barrier were present for companies who were recognizing fake profits.

Preventive measures were taken by companies to eliminate the risk of fraud

The entity and management have the main accountability for the anticipation and detection of fraud. According to Caylor(2010) it is important that the management places strong prominence on prevention of fraud and reducing the chances of fraud. For this, a total commitment is required on the part of the management for creating a culture, which enhances honesty and ethical behaviour. Study of Härkönen(2017) shows that various efforts have to be taken by management to control influence on earnings which impact theperformance of the entity. The various measures that can be used in this regard are enumerated as below:

The administrative system- the companies willing to control fraud implement a system of notification at the employee level with respect to the risks they are probably of getting exposed to (Petra?cu and Tieanu, 2014). This is a mechanism of protecting cautious employees by identifyingdeviations and communicating these to the management.

The informational systemprovides for the transparency of information both internal and external the company and its users and therefore creating a safe environment, where there are controlled changes and that early identification of various transitions which fall outside the prescribed limit (Young, 2013).

The control systemAccording to study of Cooper, Dacin and Palmer(2013) to avoidfunctions accumulating at the employee levels,development of autonomousdepartments should be done for control and audit and there should be implementation of ‘business monitoring system’.

Part 2

Journal articles and critique of research methods used

Significant Journal articles

Caylor, M.L., 2010. Strategic revenue recognition to achieve earnings benchmarks. Journal of Accounting and Public Policy, 29(1), pp.82-95.

Cetin, G., Demirçiftçi, T., &Bilgihan, A. (2016). Meeting revenue management challenges: Knowledge, skills and abilities.International Journal of Hospitality Management, 57, 132-142.

Libby, R. and Emmett, S.A., 2014. Earnings presentation effects on managerial reporting choices and investor decisions.Accounting and Business Research, 44(4), pp.410-438.

Caylor, M.L. (2010) constructed a framework for the normal change in short-run deferred revenue of the sample firms to identify unusual changes in short run deferred revenue. A similar model was derived for the normal change in gross accounts receivables for identifying unusual changes in the same. Then he estimated pre-managed earnings by eliminating the discretionary element pertaining to the concerned account and then tested whether unusual changes in all the revenue accounts was greater than desired for the sample companies. The researcher examined companies with both accounts to identify if managers favor one account as a way for discretion in revenue recognition. The research method used was helpful in reaching the desired conclusion because it provided the very first descriptive evidence on deferred revenues, displaying that several high-tech firms have on their balance sheets. Secondly, it gives the first comprehensive evaluation of revenue manipulation pertaining to all 3 earning standards.The study identified that that the mutual project conducted by the IASB and FASB for reducing managerial projection in revenue recognition might have the unexpected consequences of resulting in higher real costs levied on the companies’ shareholders are likely to employ even higher discretion in accounts receivables. The main limitations of the research method used were mainly related to cost, time and access to data. As empirical investigations of such nature need soliciting participation and data collection from several business firms and more so their accounts, the time needed for these stages of the study was only somewhat under the control of the author. On site visits by the researcher demanded cash outlays for many things which are not needed in conceptual studies. Finally, even though the researcher gained access to the firms, but there was reluctance on part of these firms to share any or all of the data required for the study. On the other hand, in their study Cetin, G., Demirçiftçi, T., &Bilgihan, A. (2016) adopted a two-phase qualitative method which included interviewing revenue managers in the first step and a focus group discussion in the second step. The research methods used were effective because the aim of the study was to determine the competencies and challenges needed to improve revenue management effectiveness. Through the two-stage method, detailed information was obtained about the typology of challenges encountered by revenue managers. However, the main limitation of using focus group was that the small sample size implied that the group may not a reasonable representation of the greater population. Another limitation identified was that the discussions were difficult to control and steer and hence time was lost to unnecessary topics. Moreover, the participants were seen as being under pressure to provide similar answers. Lastly, Libby, R. and Emett, S.A. (2014) surveyed recent studies on the impacts of earnings presentation characteristics on managers and the behaviour of users. The literature discussed by the researchers pertains to 3 main earnings presentation features: 1) disaggregation, 2) location and 3) narrative attributes. The research method used did help in reaching the intended conclusion. However, the researchers only studied the American researches which makes generalization of findings a bit difficult because accounting practices differ from country to country.

The research methods used in all three studies were completely different from one another, yet fulfilling for the purpose of their respective studies. While the first research undertook the creation of a model and was an empirical investigation, the second one used qualitative methods for more explanatory answers to the research questions. The last study was a primarily a secondary research.While the quality of research under the first two studies was controlled by the researchers, however, the same was not true for the third study as the original data has been collected by someone else. Resultantly, the quality of such research ought to be examined closely as the origins of the data might be arguable.

Part 3

Conclusion:

As per the present study, the conclusion can be drawn that there are various theoretical frameworks available with the companies with which they can prevent the occurrence of fraud in major transactions like revenue recognition. There are also various revenue recognition methods which are provided by the standard making authorities. The companies can select amongst them as to which method best suits their accounting system. The ISA has also proposed a new paradigm for accounting wherein the auditor shall assess the analytical procedures of the firm the end of the audit and form an overall conclusion on the reports prepared by the accountant and the management. This model will determine as to whether or not the financial statements are consistent thereby indicating the earlier unrecognised risk of fraud and material misstatement. There are also various preventive measures devised at the company level with which there can be thesubstantial minimization of material misstatement.

References:

Books and journals

Caylor, M.L., 2010. Strategic revenue recognition to achieve earnings benchmarks. Journal of Accounting and Public Policy, 29(1), pp.82-95.

Cetin, G., Demirçiftçi, T., &Bilgihan, A. (2016). Meeting challenges of revenue management: Knowledge, skills and abilities.International Journal of Hospitality Management, 57, 132-142.

Cooper, D.J., Dacin, T. and Palmer, D.A., 2013. Fraud in accounting, organizations and society: Extending the boundaries of research.

Dutta, S.K., 2013. Statistical techniques for forensic accounting: understanding the theory and application of data analysis. FT Press.

Gilliam, T.A., 2014. Revenue management: The use of order backlog tomet revenue reporting targets (Doctoral dissertation, The Florida State University).

Härkönen, H., 2017. The relationship between corporate social responsibility and earnings management in listed companies.

Ikechukwu, O.I., 2013. Earnings management and corporate governance. Research Journal of Finance and Accounting, 4(3), pp.51-56.

Libby, R. and Emmett, S.A., 2014. Earnings presentation effects on manager reporting choices and investor decisions.Accounting and Business Research, 44(4), pp.410-438.

Petra?cu, D. and Tieanu, A., 2014. The Role of Internal Audit in Fraud Prevention and Detection. Procedia Economics and Finance, 16, pp.489-497.

Piper, T., 2016. Creative accounting: The effectiveness of financial reporting in the UK. Springer.

Rahman, M.M., Moniruzzaman, M. and Sharif, M.J., 2013. Techniques, motives and controls of earnings management. International Journal of Information Technology and Business Management, 11(1), pp.22-34.

Sharma, A. and Panigrahi, P.K., 2013. A review of financial accounting fraud detection based on data mining techniques. arXiv preprint arXiv:1309.3944.

Tassadaq, F. and Malik, Q.A., 2015. Creative Accounting & Financial Reporting: Model Development & Empirical Testing. International Journal of Economics and Financial Issues, 5(2).

Weiss, J.W., 2014. Business ethics: A stakeholder and issues management approach. Berrett-Koehler Publishers.

Young, M.R., 2013. Financial Fraud Prevention and Detection: Governance and Effective Practices. John Wiley & Sons.