Thursday, July 31, 2014

Consideration of Accounting Errors and Fraud In Financial Reporting


The financial health and stability of a company. One of the main purposes of financial reporting is to provide shareholders and investors with accurate information, so they can make adequate decisions. Therefore, it is vital to accurately report financial information. Even the slightest error that may seem immaterial can have a large impact on important financial ratios. Firms should report the corrections to errors as prior period adjustments including that changes to previous period financial statements were needed. It is vital that the total values of assets and liabilities from the prior periods be adjusted for a cumulative effect. 

This cumulative effect will equal the needed adjustment to the balance of retained earnings. Some common accounting errors include mathematical mistakes, unrealistic estimations, failure to accrue expenses or revenues at the end of a period, misuse of facts, and incorrect classification. However, there is a fine-line between an error and fraud. Fraud is crime in which people or businesses purposely provide incorrect information for personal gain. Firms can commit fraud a variety of ways for a variety of reasons; it is a serious matter that ultimately misrepresents the firms financial position.

The moment a company finds an error in reporting, the error must be corrected. The company corrects errors from prior periods by making an adjustment to their retained earnings for the current accounting period. Subsequently, these transactional corrections are called prior period adjustments. When estimations are needed, it is important to use realistic and accurate numbers, so the amounts involved are accurate. The estimations that are involved with depreciation expense can be vital in the creation of their bottom line. If depreciation expense is overstated, the firms net income will be understated. At the same time, if a company understates depreciation expense, they will have a higher net income.

Consequently, estimations and non-cash expenses have a significant impact on a company's bottom line; therefore, must be reported as accurately as possible.
If a firm recognizes a change in an estimate must be made, the company must use the new, configured basis for reporting on current and future financial statements. However, no changes are to be made to prior period financial statements. Also, current period opening balances should not be adjusted due to the effects in prior periods.

If a company needs to be a change the way they are reporting entity, they must do this retrospectively. Therefore, the firm must restate their financial statements of previous periods. They must also provide the reason and nature of the change and the changes effect on the bottom line and earnings per share for all prior presented periods. 

When a firm needs to change their accounting principle, they must do this retrospectively. A change in accounting principle is when a firm changes from one generally accepted accounting principle to another: for example, if the United States were to adopt International Financial Reporting Standards, companies would have to retrospectively change their financial statements that they recorded under Generally Accepted Accounting Principles. Therefore, if a change in principle occurs, a company must change their financial statements for all previously presented periods. 

The year that the accounting principle occurs, the company must disclose the effects of net income and earnings per share that occurred during the prior periods. An adjustment to the retained earnings balance in the earliest presented year also needs to be completed. If decides to change from FIFO to LIFO it is impractical to determine the occurring effects during the previously recorded periods. Therefore, the company is not to change income from previous years. For all subsequent LIFO computations, the firm must use opening inventory for the year the method is adopted as the base year inventory. Finally, the firm must disclose the occurring effects and specify the reasoning behind omitting the computation of the cumulative effect and proforma  amounts.
There is a fine line between an accounting error and change and committing the crime of fraud. Firms and individuals usually commit fraud for the financial gain. Therefore, fear of losing your job, difficult financial goals, personal bonuses, and to maintain financial performance are all factors that come into play. For example, it is two days away from the end of the period and you are only a few sales away from earning that big bonus, but it does not look like you are going to get there. So, you decide to make a deal with a close contact to buy some inventory which you will buy back after the period. 

This is an instance of misrepresenting sales in order to get paid which is fraud. As you can see there is a distinct difference between an accounting error and change in relation to fraud. Errors, changes, and fraud are major components of the accounting profession. Fraud should try to be prevented proactively through internal control, while errors and changes should be dealt with either prospectively or retrospectively.

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