--%>

Discretion can distort results

Discuss how management’s discretion in applying accounting rules can mislead investors. Provide three examples and how the discretion can distort results?

E

Expert

Verified

If there were no accounting standards and no law to dictate the accounting principles and policies then there would not be a single financial statement without any manipulation.

If the management has their own discretion in applying accounting rules then they would always prepare accounts in a way which will be beneficial for them. They will prepare accounts so as to mislead stock holders, investors, lenders and can pocket huge amount.

Suppose if a company is following straight line method of depreciation then if they were no restriction on applying a method consistently then, the management could have a good opportunity to apply different method of depreciation each year as per their requirement either to increase profit or decrease profit. They would identify the method which is beneficial for them in the given situation and would apply them and no one can make out this fraud going in the company.

Secondly, for example if a company is following accrual method of accounting it has to follow accrual method only. There can be an instance where management has  purchased huge stock irrespective of the need of the company ,may be for his own interest, and he can then apply cash method of accounting and can show purchases as per the requirement of the company and can adjust cash somewhere else.

Another example is in the valuation of inventories, if a company is using First in first out method or last in first out method or weighted average method then it has to use it consistently. Otherwise, management is always in the possession to manipulate accounts in their favour, thereby misleading, users of financial statements. Incorrect value of inventories, cost of goods sold can change the profit actually earned by the company.

A financial analyst should be aware that different accounting methods employed by different firms and by the similar firm in different years complicate comparisons. Financial ratios, for illustration, will differ whenever different accounting methods are employed, even when there are no dissimilarities in attributes being compared. Investors and Creditors also need to be alert to instances in which companies change accounting methods. Managers try to compensate for downturn in the actual performance by changing the method which will help them to increase the profit.

   Related Questions in Corporate Finance

  • Q : Explain Financial Management Financial

    Financial Management: It means organizing, planning, directing and controlling the financial activities like procurement and use of funds of enterprise. This means exerting general management principles to the financial resources of enterprise. <

  • Q : Define Economy Impacts Economy Impacts

    Economy Impacts: An upcoming economy is indicated by rise in stock market, as stock market is primary indicator of a economic strength of a country. Progressing economy results in market boom. Yield of companies’ increases on improving economy,

  • Q : Explain breakthroughs on

    Explain breakthroughs on low-discrepancy sequences.

  • Q : Long-Term Financing Needed Long-Term

    Long-Term Financing Needed : - At year-end 2012, total assets for Ambrose Inc. were $1.2 million and accounts payable were $375,000. Sales, which in 2012 were $2.5 million, are expected to increase by 25% in 2013. Total ass

  • Q : Data Case Please assist with the

    Please assist with the attached Data Case assignment

  • Q : Problem on exponential growth rate

    Atlanta Company stock is predicted to follow an exponential growth rate. The relationship among the current stock price P0, future price PT after time T, and continuously compounded rate of the return r, is: PT = P0eγT. The stock doesn’t pay any

  • Q : Finance A middle income worker, with a

    A middle income worker, with a dependent spouse older than the normal retirement age, retired in January 2004. In the year prior to retirement, her gross monthly earnings were $1,500. Her Social Security pension benefit is $1,000 per month. Prior to retirement, she was subject to total taxes on her

  • Q : Iterative System Solvers Iterative

    Iterative System Solvers, Power Methods, and the Inverse Power Method for Boundary Value Problems. 1. Code and test Jacobi and Gauss-Sidel solvers for arbitrary diagonally dominant linear systems. 2. Compare performance/results with tridiagonal Gaussian elimination so

  • Q : State Transition Management Transition

    Transition Management: It is a financial service accessible to institutional investors who require making significant modifications to their portfolios, like merging, selling, or substantially restructuring them. This procedure can expose investors to

  • Q : Attributes of debt securities What are

    What are the Attributes of debt securities?