You Are An Accounting Student Taking A Class In Accounting

You Are An Accounting Student Taking A Class In Accounting Your Profe

You Are An Accounting Student Taking A Class In Accounting Your Profe

You are an accounting student taking a class in accounting. Your professor has given you a weekend assignment to analyze certain ethical scenarios in accounting practice. The scenarios include issues related to recording transactions accurately, ethical considerations in partnership profit sharing, and compliance with GAAP guidelines on consolidating entities. You are required to evaluate each scenario, determine appropriate accounting treatments, and discuss the ethical implications involved. Additionally, you need to research recent GAAP guidelines for consolidating entities and provide an example of unethical behavior related to this area.

Paper For Above instruction

Accounting ethics and compliance with Generally Accepted Accounting Principles (GAAP) are fundamental to maintaining integrity in financial reporting. The scenarios presented involve critical ethical considerations and demonstrate the importance of accuracy, transparency, and adherence to regulatory standards. A comprehensive analysis of these situations highlights the implications of unethical decisions and the importance of evolving accounting standards to prevent manipulation and misuse of financial data.

Ethical and Accounting Treatment of Personal Items in Small Business

The first scenario involves a partnership between Mr. Right and Mr. Wrong who co-own an antique store. Mr. Wrong makes a journal entry recording the personal use of a $5,000 antique by debiting Cost of Goods Sold and crediting Inventory, which inaccurately reflects the transaction. The proper accounting treatment for personal use of inventory in a business setting should involve recording it as a withdrawal or drawing rather than expense recognition. This transaction should be recorded by debiting Drawings or Owner’s Equity account and crediting Inventory, not Cost of Goods Sold. This approach accurately reflects the transfer of assets for personal use without artificially inflating costs or misrepresenting expenses, which could distort the financial statements.

Ethically, Mr. Wrong’s action is problematic because it misstates financial results by inflating expenses and decreasing inventory. Recording personal use as Cost of Goods Sold could lead to misleading financial statements, potentially affecting decision-making by stakeholders, including partners, lenders, and auditors. Transparent and honest accounting demands that personal transactions in partnership settings be clearly documented and properly classified, ensuring that the financial data remains credible and reliable.

Profit Sharing Disputes in Partnerships

The second scenario involves Mr. White and Mr. Black, who operate a marketing firm with profits shared according to initial investments (2:1 ratio) and manage different aspects of the business. After discovering that the previous year’s net income was understated by $60,000, Mr. White argues that the additional income should be shared based on current capital balances, while Mr. Black advocates for sharing based on the profit-sharing ratio (2:1).

According to accounting standards, the correct approach depends on the nature of the adjustment. Adjustments to prior period net income should generally be allocated based on the original profit-sharing agreement unless the partnership agreement states otherwise. The profit-sharing ratio (2:1) is based on initial agreements and contributions; therefore, Mr. White’s argument aligns with the legal and contractual basis of profit sharing. The ratio of current capital balances (approximately 60/40) reflects their ownership stake but does not override the original profit-sharing agreement unless explicitly stated in the partnership contract. Typically, adjustments to prior period income are allocated in accordance with the original profit-sharing ratio, making Mr. Black’s position correct unless new contractual provisions specify otherwise.

Thus, the proper course would be to allocate the additional $60,000 based on the original profit-sharing ratio of 2:1. Doing so ensures consistency with the partnership agreement and maintains fairness and integrity in distributing profits and correcting revenue recognition discrepancies.

GAAP Guidelines on Consolidation and Ethical Concerns

GAAP rules stipulate that a company must consolidate financial statements when it has a controlling financial interest in another entity, typically owning more than 50% of voting stock. However, companies have exploited this rule by establishing arrangements or structures that obscure control, such as voting agreements or special voting rights, circumventing this threshold. Such loopholes can distort the true financial position of a group of companies and mislead investors, creditors, and regulators. The ramifications are severe, including wrongful asset undervaluation, inflated assets, or liabilities, leading to distorted financial ratios and potential legal consequences.

In response, the Financial Accounting Standards Board (FASB) issued new guidelines, known as Accounting Standards Update (ASU) 2017-01 and subsequent amendments, to address these loopholes. These standards expanded the criteria for consolidation, emphasizing the importance of assessing whether a company has the power to direct the activities of another entity that significantly impact its economic performance, even if it does not hold a majority voting interest. For example, control can be achieved through contractual arrangements, economic dependence, or other means besides ownership percentage.

An illustrative case of unethical behavior occurred with Enron Corporation, which manipulated off-balance-sheet entities and complex contractual arrangements to conceal debt and inflate earnings, thus misleading investors and regulators. Enron exploited loopholes in GAAP to avoid consolidating these entities, ultimately resulting in one of the largest corporate scandals in history. The Enron scandal underscored the necessity for stricter and clearer standards, leading to reforms that enhance transparency and prevent manipulation.

These reforms aim to promote fairness, transparency, and investor confidence by ensuring that all entities with control are properly consolidated according to updated standards, reducing opportunities for manipulation and unethical behavior in financial reporting.

Conclusion

Ethical conduct and strict adherence to accounting standards are essential to maintaining trust in financial reporting. From proper recording of personal use of inventory to fair profit sharing and compliance with consolidation rules, accountants play a vital role in ensuring transparency and integrity. The evolution of GAAP guidelines reflects ongoing efforts to plug loopholes and address unethical practices that threaten the financial robustness of corporations. Ultimately, embracing ethical standards and regulatory compliance safeguards stakeholder interests, promotes corporate accountability, and sustains confidence in the capital markets.

References

  • FASB. (2017). Accounting Standards Update No. 2017-01, Clarifying the Scope of Asset Derecognition. Financial Accounting Standards Board.
  • FASB. (2018). Revenue from Contracts with Customers (ASC 606). Financial Accounting Standards Board.
  • Enron Task Force. (2003). Final Report on the Collapse of Enron Corporation. U.S. Department of Justice.
  • Healy, P. M., & Palepu, K. G. (2003). The Fall of Enron. Journal of Economic Perspectives, 17(2), 3-26.
  • Financial Accounting Standards Board (FASB). (2018). ASC 810 - Consolidation. Retrieved from https://asc.fasb.org
  • Schipper, K., & Vincent, L. (2003). Earnings Management. Accounting Horizons, 17(4), 365-383.
  • International Accounting Standards Board (IASB). (2019). IFRS 10 - Consolidated Financial Statements. IASB.
  • U.S. Securities and Exchange Commission. (2002). Management’s Discussion and Analysis of Financial Condition and Results of Operations; Interpretive Release. SEC.
  • Beatty, A., Chamberlain, S. L., & Liao, S. (2018). The Effects of Mandatory IFRS Adoption on International Financial Reporting. Accounting Review, 95(4), 33-70.
  • Banker, R. D., & Hughes, J. (2007). The Relationship between Control System Effectiveness and Ethical Behavior. The Accounting Review, 82(4), 1059-1084.

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