The Accounting System Weaknesses And Loopholes

The ultimate aim of fiscal coverage is to supply utile information to investors, creditors and others for doing rational and productive determination. The Generally Accepted Accounting Principles ( GAAP ) is a set of rules that provide a basic guideline to directors in fixing fiscal statements. These rules normally are flexible and allow directors to utilize their judgement to describe the implicit in economic sciences of their organisations expeditiously and efficaciously.

During 1996-1998, legion articles and SEC probes have brought to light patterns that either push the boundaries of GAAP or are considered out right fraud. In some cases, the independent hearer has been blamed for non catching or rectifying entries that are questionable. Besides, it is clear that direction intended to lead on outside hearers and audit commissions. The most common offense method is by improper acknowledgment of gross. Companies have managed their net incomes in a assortment of ways runing from over/under gauging bad debt disbursal to entering non-existent gross revenues.

Gaining Management

Net incomes direction occurs when directors use judgement in fiscal coverage and in structuring minutess to change fiscal studies to either misdirect some stakeholders about the implicit in economic public presentation of the company or to act upon contractual results that depend on reported accounting Numberss ( HEALY ; WAHLEN, 1999, P. 368 ) .

However, gaining direction seems to be a controversial affair as it depends largely on director judgement in doing determinations. The judgement will change in either ways and they will be pros and cons behind those determination. While the SEC and most faculty members consider the pattern of gaining direction will misdirect some users of fiscal information, on the other custodies, some comptrollers and directors argue that some options of net incomes direction legitimate managerial patterns.

Dechow and Skinner ( 2000 ) figured out that it is hard to place net incomes direction when it occurs within the bounds of GAAP. Harmonizing to them,

“ While some fiscal coverage picks that clearly violate GAAP can represent both fraud and net incomes direction, other picks, within GAAP, can represent net incomes direction. The cardinal point to be made is that there is a clear conceptual differentiation between deceitful accounting patterns ( that clearly demonstrate purpose to lead on ) and those judgements and estimates that autumn within GAAP but may consist net incomes direction depending on managerial purpose. However, in the latter types of pick it would, in many instances, seem hard, absent some nonsubjective grounds of purpose, to separate net incomes direction from the legitimate exercising of accounting discretion. ”

During 1998 address at “ The ‘Numbers Game ‘ , SEC Chairman Arthur Levitt expressed his concern that there are inordinate corporate directors, hearers and analysts let the desire to run into net incomes outlooks override good concern patterns. His fright was that “ Managing may be giving manner to use ; Integrity may be losing out to semblance. ” Chairman Levitt stated that authorities ordinance was non the solution to this job.

Chairman Levitt identified five common accounting rules that have been used in manipulating net incomes:

Lucent ‘s Manipulation Method

Possible Incentives

Stock market motives

During its growing stage ( from 1996 to 1999 ) , Lucent ‘s major inducement was to maintain on describing net incomes and grosss above market outlook, as to increase their market capitalisation ( benefit from the premium that the investing community awards uninterrupted high public presentation companies ) ( BARTH ; ELLIOT ; FINN, 1999 ) . As virtually all companies, Lucent besides has the strong inducements to smooth net incomes to do it look less volatile.

Contract motives

Inflating net incomes to increase direction compensation is a strong inducement to pull strings net incomes. Harmonizing to the information displayed in the proxy statement for twelvemonth 2002, all of the top directors and most of the managers have public presentation wage programs based upon some accounting steps such as net incomes and grosss.

Besides, heightening occupation security can be considered as an inducement to pull off net incomes to do the house look more profitable. Reducing the cost of capital can be considered another major inducement to directors. Because of following aggressive growing scheme, Lucent was invariably publishing debt to get irms. Therefore, the company will hold strong inducements to show strong, healthy, and steady fiscal statements to cut down the cost of debt.

Manipulation Method

Assorted cooky jar militias and large bath restructuring charges

Lucent ‘s net incomes are benefited from $ 2.8 billion modesty for “ large bath ” restructuring charges that were recorded as portion of the procedure during the Lucent ‘s by-product from AT & A ; T ( McGough 1999 ) . By composing off several old ages worth of costs at one time, Lucent eliminated future costs and automatically improved future net incomes ( Byrnes, Melcher, Sparks ) . Although entering restructuring costs is allowed by GAAP, some analysts believe Lucent put aside far more than was needed to cover restructuring disbursals. The extra militias helped Lucent smooth net incomes by leting it to add back $ 382 million to pretax income ( Business Week-Byrnes, Mecher, Sparks )

In procedure research and development ( IPRD ) write-down

In October 1998, Business Week reported that Lucent had avoided some good will amortisation by composing off $ 2.3 billion of in-process research and development for companies was acquired. Over its being, Lucent has engaged in 40 acquisition dealing with other companies. An accounting expert and money director notes that

In financial twelvemonth 1996, Lucent existent net incomes would hold lost $ 49 million alternatively of $ 1.05 billion operating additions which it had reported,

Lucent ‘s financial 1997 net incomes would hold been $ 1.11 billion alternatively of $ 1.51 billion,

Net incomes for the first three quarters of 1998 would hold been $ 1.51 billion alternatively of the $ 1.74 billion reported if Lucent had non been engaged in the erstwhile charge and in-process research and development write away. ( Byrnes, Melcher, Sparks )

Premature or aggressive gross acknowledgment

Two-thirdss of the $ 679 million decrease in gross was really attributed to “ impart stuffing ” gross revenues, whereby the transportations of merchandises to distributers are recorded as gross revenues even though the merchandises are non yet sold to end-users ( Electronic News, Feb 2001, Murphy ) . Other gross revenues were nullified because

Customers were promised price reductions, credits, and rights of return ( WSJ March 2001 Berman, Blumenstein ) , or

Lucent had improperly recognized care understandings as package licence gross ( Internet Week, Moozakis ) .

Lucent had deducted $ 199 million in credits offered to clients and $ 28 million for a partial cargo of equipment as portion of the December 2000 restatement. In add-on, the company took back another extra $ 452 million in gross for some merchandises it had sent to its distribution spouses but really it ne’er sold to stop clients ( WSJ, Feb 2001, Berman, Schroeder, Young ) . By prematurely entering gross revenues of care understandings, prematurely entering gross revenues made to distributers, and offering price reductions, erstwhile credits and other inducements for clients to order merchandises in progress of their demands,

Lucent ‘s patterns “ borrowed ” to a great extent from future gross revenues ( WSJ March 2001, Berman Blumenstein ) . As Lucent ‘s ” debt ” mounted from one-fourth to one-fourth, it became more and more hard to run into analysts ‘ gross revenues and net incomes outlooks. To keep its gross projections, Lucent had to scramble to book gross at the terminal of each one-fourth. A former executive at AT & A ; T noted that “ At the terminal of each one-fourth, I ‘d acquire calls from the Lucent guysaˆ¦They were offering shouting trades ” ( WSJ March 2001 Berman, Blumenstein ) . Shortly after financial twelvemonth stoping September 2000, a Lucent employee calculated that gross revenues ensuing from aggressive tactics such as giving clients erstwhile promises of credits toward future purchases totaled about $ 1.8 billion ( WSJ March 2001 Berman, Blumenstein ) .

Gross outgo and Capital outgo