Chapter 5:financial and accounting

– Management manipulates financial statements to deceive investors... Safeguards to Counter Problems • Internal Controls – Help to protect assets and increase reliability of accounting r

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Chapter 5

Ensuring the Integrity of Financial Information

Albrecht, Stice, Stice, Swain

2

3

Types of Problems

• Errors

– Unintentional mistakes

• Disagreements

– Accounting judgments

– Different incentives

• Fraud

– Intentional errors

– Management manipulates financial statements to deceive investors

Accounting Errors

• Errors in transactions and journal entries.

– Amounts are incorrect

– Incorrect accounts involved

• Errors in accounts and ledgers.

– Posting to the wrong account

– Posting the wrong amount

6

Safeguards to Counter Problems

• Internal Controls

– Help to protect assets and increase reliability

of accounting records

• Internal Control Structure

– The control environment

• Actions, policies, and procedures that reflect the attitude of management about controls.

– The accounting systems

– The control procedures (activities)

Control Activities

• Preventative Controls

– Segregation of duties

– Proper procedures for authorization

– Physical control over assets and records

• Detective Controls

– Adequate documents and records

– Independent checks on performance

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Segregation of Duties

1 Authorization

– Authorizing or approving the execution of

the transaction

2 Record Keeping

– Recording the transaction

in the account

3 Custody of Assets

– Having physical possession of or control

over the assets involved

C

RK A

C

Reasons for Earnings

Management

• Meet internal targets.

• Meet external expectations.

• Income smoothing.

– Carefully timing the recognition of revenues and expenses to even out earnings from year

to year

• Window dressing for an initial public

offering or loan.

– Making the earnings look as good as possible for investors and/or bankers

12

Earnings Management

Continuum

Savvy

Transaction

Timing

Aggressive Accounting

Deceptive Accounting

Fraudulent Reporting Fraud

Strategic

Matching

Changes in Methods or Estimates with Full Disclosure

Changes in Methods or Estimates but with Little

or No Disclosure

Non-GAAP Accounting

Fictitious Transactions

The GAAP Oval

B

Which one is correct?

The Sarbanes-Oxley Act

• Public Company Accounting Oversight

Board (PCAOB)

– Oversees the accounting firms

• Constraints on Auditors

– Accounting firms can no longer provide

certain services to audit clients

• Constraints on Management

– Requirements to ensure stronger and more ethical management

The Role of Auditors

• Provide a check and balance

• Internal Auditors

– Ensure integrity in the financial records

– Evaluate and encourage adherence to

internal controls

• External Auditors

– Ensure integrity in the financial reporting

process through independent audits of

financial statements

What Auditors Do

• Processes used by auditors

– Interview (internal and external)

– Observation (internal and external)

– Sampling (internal and external)

– Confirmation (external)

– Analytical Procedures (external)

• Follow Generally Accepted Auditing

Standards (GAAS)