Introduction
In the recent past, there was a major accounting scandal in the United States of America that hit the news headlines across the globe. An American car rental company known as Hertz is under pressure from the Securities and Exchange Commission (SEC) for flouting a number of the generally accepted accounting principles (GAAP). The demand has been so immense that the company is compelled to restate its statements for various periods. Given the above situation, the paper seeks to discuss the principle of materiality, full disclosure principle, and the principle of reliability, relevance, and consistency. Notably, these are the three fundamental GAAP principles that Hertz Company breached resulting in an accounting scandal.
The Principle of Materiality
It is important to note that financial statements are material if they can influence the user’s economic judgments. In Hertz Company’s case, pre-tax income was materially misstated as a result of accounting errors arising from various business units over several reporting periods (U.S. Securities and Exchange Commission, 2018). Remarkably, the accounting errors were made due to the pressured corporate environment that emphasized on meeting internal budgets, earnings estimates and business plans. Accordingly, Hertz Company ended up paying less tax than it ought to have paid since the calculations were based on manipulated financial statements.
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Furthermore, Hertz Company made wrong economic decisions on the presumption that the company had achieved its set targets. For instance, Hertz Company gave the senior executive managers incentives for a job well done as portrayed by the manipulated financial documents (Accounting Today, 2019). Remarkably, the company relied on wrong statements in calculating senior executive managers’ incentives. Breaching of the concept of materiality creeps in when making judgments on rewarding top management based on wrong financial statements. In reality, the set company targets were not met and hence the company’s quest to claw back such compensations from executive management.
Full Disclosure Principle
In essence, full disclosure principle requires that the management should tell the external users all the material information about the company to enable them to make informed decisions. Hertz Company violates the full disclosure principle by not adequately disclosing a decision that entailed extending of the planned holding periods for considerable portions of its United States rental car fleet (Accounting Web, 2014). By taking the stance above, Hertz’s statements were beneficial in the short-term, but in essence, very misleading as the depreciation expense became low for current quarters, but the hidden reality was that maintenance costs would sky-rocket in the long-term and dent Hertz’s premium brand.
Moreover, Hertz Company made changes in accounting policies without full disclosure as required by the generally accepted accounting principles. The above step was gross misconduct and a well-orchestrated move to manipulate the financial statements. Consequently, the company had inaccurate representations of its earnings and thereby misinforming the external users on the position of the company as at the particular period. Besides, the erroneous financial statements worked to the advantage of the executive management as they were in a place to achieve their targets and in turn earn incentives.
Reliability, Relevance, and Consistency
For financial information to be useful, it has to be reliable, relevant and consistent. Hertz Company flouted the above principle as it resorted to the use of improper methodologies to determine allowances and write-offs for aged receivables (U.S. Securities and Exchange Commission, 2018). For instance, in 2013, under intense budget pressure, the methodology was reworked to ascertain a favorable outcome which was equivalent to breaking the principle of consistency. It is important to point out that for consistency purposes, accounting information is prepared using the same methods in each accounting period to allow for comparisons between different accounting periods. Unfortunately, this was not the case in Hertz case.
Additionally, Hertz Company breaches the concept of reliability that stipulates that accounting information should be true, accurate and fair when it intentionally lowers its 2013 earnings guidance. Hence, the financial statements from the company could not come handy in making choices and consequently flouting GAAP principles. Therefore, financial statements from Hertz were not reliable enough to base economic judgments on and probably the cause for restatement after thorough investigations by the Securities and Exchange Commission. Moreover, a review of previous Hertz accounts reveals errors in financial statements that prompted the need for restatement and a further indicator for untrue statements (Accounting Web, 2014).
The concept of relevance comes about when a decision maker needs to understand the company’s performance over some time before making an informed decision on time. One can get to gauge the company’s past performance, its current condition, and its future outlook before arriving at a great judgment. Review of Hertz’s financial accounts and consequent restatement shows that most of the financial statements were not accurate, correct and fair, and therefore not relevant to both internal and external users in making vital decisions (Accounting Today, 2019). The entire concept of Reliability, consistency, and relevance lacked on the Hertz financial statements.
Conclusion
From the above discussion, it is deducible that Hertz Car Rental Company flouted fundamental GAAP principles that culminated to a mega accounting scandal that has been, and is still the talk of the town in the United States of America. To begin with, it violated the principle of materiality that misguided economic judgments. Also, the company breached the full disclosure principle by not giving adequate information on extending planned holding periods, and ultimately, the company violated the principle of reliability, relevance, and consistency by manipulating financial reports. Therefore, it can be presumed that breaching of GAAP principles paved the way to the mega accounting scandal in Hertz Car Rental Company.
References
Accounting Today. (2019). Hertz Seeks $70 Million in Clawbacks Tied to Accounting Scandal. Retrieved from https://www.accountingtoday.com/articles/hertz-seeks-70m-in-clawbacks-tied-to-accounting-scandal
Accounting Web. (2014). Hertz Accounting Errors Exposed. Retrieved from https://www.accountingweb.co.uk/business/finance-strategy/hertz-accounting-errors-exposed
U.S. Securities and Exchange Commission. (2018). Agency Financial Report: Fiscal Year 2018. Retrieved from https://www.sec.gov/files/sec-2018-agency-financial-report.pdf
