FASB and SEC since free market forces

Bill Simon says, “We should get rid of the FASB and SEC since free market forces will make sure that companies report reliable information.” Do you agree? Why or why not? I disagree for several reasons. One, investors view profits a measure of managers’ performance, therefore giving managers an incentive to use their accounting discretion to distort reported profits by making biased assumptions. Many top managers receive bonus compensation if they exceed certain pre-specified profit targets. Furthermore, stock option awards can also entice a manager to manage earnings in their favor. Regulation and generally accepted accounting standards help deter managers’ from taking this too far.

Managers of some firms may make accounting decisions to influence regulatory outcomes in such situations where accounting numbers are used like in tax policies and import tariffs. Accounting decisions by managers may also be made to influence the perception of important stakeholders and capital markets. Uniform accounting standards reduce managers’ ability to record similar economic transactions in dissimilar ways, ultimately creating a uniform accounting language and increasing the credibility of the financial statements by limiting a firm’s ability to distort them. The potential threat of lawsuits and penalties generally improves the accuracy of disclose. Significant legal liability enforced by the SEC tends to also discourage management and auditors from supporting accounting proposals where management and auditor judgment, as well as increased complexity come into play. Ultimately, without the SEC or FASB, managers would not have to disclose any information and the quality of accounting would significantly decrease.

4.) Many firms recognize revenues at the point of shipment. This provides an incentive to accelerate revenues by shipping goods at the end of the quarter. Consider two companies, one of which ships its product evenly throughout the quarter, and the second, which ships all its products in the last two weeks of the quarter. Each company’s customer pays 30 days after receiving shipment. Using accounting ratios, how can you distinguish these companies?

In regards to the income statements, there are no differences between the two companies because both companies have the same amount of expenses and revenues. In regards to their balance sheets however, the companies are different. The company that ships all of its products in the last two weeks of the quarter will have a higher account receivable balance and lower cash than the company that ships its product evenly throughout the quarter. Accounts Receivable Turnover [= Sales / Accounts Receivable]

The company who ships its product in the last two weeks of the quarter will have a lower accounts receivable turnover ratio compared to the company which ships its product evenly throughout the quarter. Cash Ratio [= Cash + Short-Term Investments / Current Liabilities] The company who ships its product in the last two weeks of the quarter will have a lower cash ratio than the company, which ships its product evenly throughout the quarter. Day Receivable [= Accounts Receivable / Average Sales Per Day] The company who ships its product in the last two weeks of the quarter will display a higher days’ receivable ratio than the company, which ships its product evenly throughout the quarter.

5.) a. If management reports truthfully, what economic events are likely to prompt the following accounting changes? Increase in the estimated life of depreciable assets

Managers often will increase the estimated life of depreciable assets when the manager realizes that the assets are likely to last longer than what was initially expected. Decrease in the uncollectible allowance as a percentage of gross receivables When a firm decides to change its customer focus, this may prompt the firm’s managers to decrease the allowance for uncollectible receivables. Recognition of revenues at the point of delivery rather than at the point cash is received Within a reasonable degree of certainty, revenues can be recognized at the point when the customer is expected to pay cash. Capitalization of a higher proportion of software R&D costs

Capitalization of a higher proportion of costs incurred on software R&D, according to SFAS No. 86, should occur after the establishment of technical and commercial feasibility.

b. What features of accounting, if any, would make it costly for dishonest managers to make the same changes without any corresponding economic changes?