Introduction
The focus of this study is on the financial reporting standards of a typical fortune 1000 company. The study is carried out in the context of the convergence of the International Financial Reporting Standards (IFRSs) and the US Generally Accepted Accounting Principles (US GAAP). The main elements assessed includes treatment of leases under both accounting standards, share-based compensation, write-downs and fraud as recognized under the auditing and accounting standards. An assessment of the impact of misstatement is assessed. It is worth noting that all publicly held accounting entities in the US are expected to follow single accounting standards in financial disclosure (Alsaqqa, 2013).
Inventory write-downs
There are damaging financial repercussions associated with the failure to include inventory write-downs in the financial statements. For instance, when the write-downs are not recognized, the accounting entity would end up having a lower cost of cost of goods sold. As a result, it will report higher profits than what is actually realized. This would result to increase tax liability to the organization. Paying of excess taxes would end up reducing the shareholder's wealth. It may also result in negative projective of the organization, making its performance look unfavorable to potential investors (Flood, 2016). Internal Revenue Service (IRS) balances should thus be resolved as fast as possible laying specific defenses. To prevent fraudulent financial reporting, the accounting entity should have internal auditors who assess the accuracy of financial information and risks of misstatements. Internal Audit Committees should adopt measures that ensure all controls are put in place to avoid fraud. Such controls include ensuring clear authorization procedures and frequent assessment of financial inflows and outflows. According to the Sarbanes Oxley Act, the CEO and the CFO are expected to assent to the financial statements, taking responsibility for any misstatements (Frederick, & Institute of Chartered Secretaries and Administrators 2014).
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It would also be unethical for the accounting entity not to make disclosure on its inventory write-offs. It would result in an overstatement of assets and equity. As a result, it would result in disclosure of misleading financial position of the accounting entities pushing the investors to make none optimum financial decisions in the accounting entity. The statements would thus be false and the move is unethical. Accounting code of ethics requires accounting entities to make accurate, objective and transparent financial disclosure (Frederick, & Institute of Chartered Secretaries and Administrators 2014).
Additional tax and penalties
A financial report that generates additional tax obligations in the future to accounting entities has many potential disadvantages to the stakeholders. For instance, such financial statements have the potential of investors suspecting the organization of earnings management. As a result, they would withdraw their investment from the organization. At the same time, their lack of confidence in the reports may seek the top management to be executed of misreporting of the financial performance of such accounting entities. At the same time, when an accounting entity maintains an inventory reserve that it does not disclose, employees may take advantage of it by misappropriating such assets (Knechel, &Salterio, 2016). Such a process would result in a scenario where the entity ends up losing assets due to its fraudulent activities. In the financial statements, misstatements would end up reducing the reliability of the financial statements in the decision-making process. As a result, many stakeholders would stop relying on such financial statements as a source of information seeking information from the insiders such as the employees. A contra entry account will reduce the ability of the accounting entity to make the right disclosure of the financial position of the accounting entity. As a result, the statements would end up misleading the investors in the decision-making process. The stakeholders would thus end up holding the accounting entity as having engaged in unethical approach to operations. Penalties to an accounting entity result to a reduction in the level of profits reported by the organization. As a result, the investors may end up withdrawing their investment from the organization if they realize that it is not maximizing their wealth (Flood, 2016).
Applicable federal tax laws
There are federal rules regarding the writing down of inventories in accounting entities. Writing of inventory that has been damaged, stolen or which is unsellable has the potential of resulting in the reduction of the tax obligation. According to the federal tax laws, an accounting entity is expected to treat such write down as part of the cost of goods sold, claim, or adjust the inventory. If the insurer paid for the loss, the loss must be reduced by such paid amount. The valuation of the inventory needs to be carried out using the accounting methods that are approved by the IRS (Waters, 2003). In the case, the organization had developed parts, which were assembled to develop equipment. In the process, it ended up developing more parts than what was required. In the ruling, it was upheld that accounting entities could only engage in write-downs if the cost of the inventory has reduced rather than merely because they had overproduced them rendering them unsellable (Knechel, &Salterio, 20160.
If the IRS audits the statements of the accounting entity, it may impose civil fraud. It is worth noting that both overstating and understating earnings is punishable by the law. In this case, failure to recognize write-downs would result in the reporting of high earnings, something that would mislead stakeholders especially investors that the organization is doing well. This was the case with Enron, where misleading higher earnings report resulted to increased investments, misleading investors to direct more of the resources towards the organization in spite of its poor performance something that led to the loss of billions of dollars of the investor's money (Flood, 2016). The accounting entity should ensure that the financial statements are restated and the right level of profits and losses disclosed to the Internal Revenue Service. Civil fraud penalty is set under IRS 6663. a penalty of 75% of the misstated amount is employed. The criminal convictions of the promoters of frauds may result in a fine amounting to $250,000 and a prison term of up to five years. In the Power tools Co versus v. Commissioner 1979, the court upheld proposed procedures by lower courts on how the accounting entities could write down their inventories (Frederick, & Institute of Chartered Secretaries and Administrators, 2014).
Stock options and SARS
ASC 718 provides a guideline on share-based compensation requires that all share-based compensation made to employees in accounting entities be accounted for at the fair value. In accordance with this code, the compensation should be treated as a liability to the organization. At the same time, the accounting entity has to pay out the share value back to the equity in order for the equity level in accounting entity to be adjusted with the same amount. There are significant between stock options and the stock appreciation rights plan (SARS). Stock appreciation rights refer to bonuses that are issued to the employees, which are equivalent to the appreciation in value of the stock over a given period. Employees benefit from SARS when the stock price rises ( Fangs hu, 2015). Unlike options where employees need to pay the exercise prices, employees awarded with such SARS do not have to pay such price and only benefits from the amount of change in the price of the stocks in terms of cash or stocks. Employees who are awarded SARS are thus not required to pay anything to the accounting entity. The risks of share options are that they dilute the ownership of the accounting entity. On the other hand, SARS results to reduction in shareholders wealth as employees are issued with cash amounting to the overall share appreciation in the market (Fosbre et al 2009).
There are different methods of accounting for share-based compensation stock options and stock appreciation rights plan (SARS). The accounting method employed in this case is as simplified in the table below:
Recording stock option
| Debit | Credit | ||
| Date | Compensation expense | XX | |
| Paid capital from stock options | XX |
To record stock appreciation rights plan (SARS).
| Debit | Credit | ||
| Date | cash | XX | |
| Rights liability | XX |
Source: Knechel, &Salterio (2016)
In the above case, it is recommended that the accounting entity should use the stock options, as they would push the employees to provide more equity to the accounting entity. It would also provide the employees with partial ownership of the accounting entity something that would act as a source of motivation in their operations. When employees own part of the organization, it is likely that they would be more motivated to be productive since they will be involved in sharing of the profits earned by an accounting entity (Frederick, & Institute of Chartered Secretaries and Administrators 2014). On the other hand, when employees lack ownership, they rely only on their salaries and may not see the need to push the organization to perform better beyond its ability to provide them with wages and salaries.
Leases
There are differences between disclosure of leases under the US GAAP and the IFRS. Under the US GAAP, only the leases that are treated as financing leases from income statement perspectives that are treated as a finance lease. Nevertheless, the lessee is expected to report the assets and liabilities related to leases on the balance sheet. On the other hand, IFRS treats all leases as financing leases. Under the US GAAP only the leases that involve plant, property, and equipment that are recognized. On the other hand, under the IFRS all forms of leases are recognized. Under US GAAP, land and buildings are classified together unlike under IFRS where they are treated separately. US GAAP provides special treatment to leveraged leases while under IFRS there is no such privileged treatment (Lemus, 2014).
Based on the above differences in the disclosure of leases, it is evident that the organization should ensure that the lease is disclosed on the bases of the accounting standards adopted. Now, there is convergent of the US GAAP with the International Financial Reporting Standards in the US. It will thus important for the organization to adopt IFRS in its financial reporting. If the organization is to adopt off-balance sheet financing, the organization will need to identify all leases on the balance sheet as IFRS 16 now requires that all leases be recognized on the balance sheet without dividing them to operating and financing leases. If the CFO is to disclose leases using US GAAP, operating leases should be recognized in the income statement and the financing leases should be presented on the balance sheet.
There are risks and benefits associated with adoption of each of the standards. Use of IFRS will result in enhanced comparability of reports with reports of other firms around the world. Nevertheless, it may result in an overstatement of assets. Use of US GAAP will limit the organization from overstating assets, though it reduces the comparability of financial statements with statements that have been established by countries that have adopted IFRS.
Single set of accounting standards
The adoption of IFRS in recognition of leases will increase comparability of the performance of financial statements across the globe. It will be thus easy to understand the provisions of financial statements. Nevertheless, the approach has the potential of resulting in an overstatement of assets where both operating and financing leases are presented on the balance sheet. It will also result in loss of special treatment of leases.
Statement on Auditing Standards (SAS 99)
Statement on Auditing Standards refers to an audit standard focusing on financial fraud. It defines fraud as an intentional act that results in the financial misstatement. It is a falsification of the financial statement. In this study, the company would thus be treated as having engaged in fraudulent activity as a result of failing to disclose write-downs with full knowledge that this would result to misleading financial position and performance of the accounting entity.
Repercussions of not issuing restated statements
Material misstatements are evident in this case due to inventory write-downs. Restatement of financial statements is necessary if the past statements have been objectives. There are three key elements associated with failure to restate. The move would result in penalties by the Internal Revenue Service. Secondly, it would result in loss of confidence on financial statements by stakeholders. Thirdly, it would result in loss of objectivity of financial statements (Knechel, &Salterio, 2016).
Economic effects
The restatement is an indicator that financial statements prepared by an accounting entity have not been credible. It indicates that the disclosure of such financial statements was not objective. Often, investors will realize negative market returns because of misstatements. There is an increase in a spread in the bid-ask continuum in accounting entities. When restatements are made investors become apprehensive of the initial disclosure and their attitude towards the accounting entity level of performance and financial position is negative (Waters, 2003).
Restatement of financial statements has adverse effects on many stakeholders. For instance, investors may have already based their investment decisions on the un-restated statements. If earnings had been reported to be higher than actual, such investors may have directed their resources towards the organization, leaving out other viable investment opportunities. The decisions that they would end up making would thus not maximize their wealth. If earnings had been underrated, the investors may equally have skipped investing in a viable firm, hence making wrong investment decisions.
To employees, restatement may result in reduced earnings. If the accounting entity provides them with performance-based payments, the organization would have overpaid them and the overpaid amount may be deducted from their future earnings.
To the customers, restatements of financial performance and position may result in reduced sales to customers reducing their discounts. To creditors, a restatement may result in an improved level of financial performance as indicated in the financial results or a reduction. In case there was an overstatement, creditors may have extended loans to a firm that is not in a position to repay these loans. As a result, the accounting entity may end up defaulting on payments something that would be a loss to the creditors (Waters, 2003).
Conclusion
Based on the above study, it is evident that accounting entities are expected to follow a specific set of standards in their accounting reporting. In this case, failure to disclose write-downs will attract penalties from the Internal Revenue Service. It will also be treated as fraud as per the auditing standards. Accounting entities are expected to treat write-downs as a loss or an increase in the cost of cost of goods sold. When it comes to leases, IFRS expects accounting entities to disclose both operating and financing leases on the balance sheet as opposed to US GAAP, which makes a distinction between the two. Employees issued with stock options are expected to pay exercise price unlike those issued with stock appreciation rights.
References
Alsaqqa, B. (2013). The Advantages and the challenges of adopting IFRSinto UAE stock market. International Journal of Business and Management, 8(19), 1-23
Fangshu, Z. (2015). Review of US GAAP and IFRS convergence: Revenue recognition aspects. Research Journal of Management Sciences, 4(5), 21-36
Flood, J. M. (2016). Wiley Practitioner's Guide to GAAS 2016: Covering all SASs, SSAEs, SSARSs, PCAOB auditing standards, and interpretations . New York: McGraw Hills
Fosbre, A. et al (2009). The globalization of accounting standards: IFRS versus US GAAP. Global Journal of Business Research , 3(1), 61-72
Frederick, D., & Institute of Chartered Secretaries and Administrators (2014). Financial reporting and analysis . New York: McGraw Hills.
Knechel, W. R., &Salterio, S. E. (2016). Auditing: Assurance and Risk . New York: McGraw Hills
Lemus, E. (2014). The similarities and differences between the financial reporting standards under the United States. G lobal Journal of Management and Business Research, 14(3), 1-7
Waters, D. (2003). Inventory control and management . New York: McGraw Hills
