Discuss The Relationship Between Accounting Choices Made By Management And The Values Reported In Financial Statements And The Possible Reasons Why Those Choices Are Made

2485 words - 10 pages

IntroductionThe Age (17 May, 1988) reported that the true picture of Wormald's financial state was revealed by the accountants, Arthur Young. After a request by the National Companies and Securities Commission (NCSC) Arthur Young prepared a revised report, increasing the original loss of $54.8 million to a loss of $255.9 million. This, of course, raises the question of why there was a difference between the reports prepared by the Wormald management and those prepared by the accountants. Section 269(9) states that `the accounts are made out in accordance with applicable approved accounting standards and that, by so doing ensures the accounts give a true and fair view.' (Australian National ...view middle of the document...

One reason behind the accounting choices made by management and the values reported in the financial statements of Wormald may be due to the separation of ownership from control. Management is in a more favorable position to know the likely and present performance of the company than would the shareholders (Whittred and Zimmer, 1988, p. 26).Typically, the majority of the shareholders of a firm hold a diversified portfolio of investments and do not normally involve themselves in the management of the firm. Management is employed to perform the decision-making role of the firm. Hence, management acts as agent for the owners (shareholders). However, the objective of management may differ from those of the firms' shareholders. Shareholders could possibly assure themselves that management will make optimal decisions, but only if appropriate incentives are given and only if the management is monitored (referred to as agency costs) (Whittred and Zimmer, 1988, p. 26). This may provide an answer to the accounting choices made that gave rise to the initial total group loss of $54.8 million.Management's wealth may have been tied to the well-being of the external shareholders. For example, if the incentives offered were 'bonus schemes and performance plans, in which management's wealth was directly linked to performance, measured in accounting terms, rather than indirectly linked as in the case of shares and share options', (Whittred and Zimmer, 1988, p. 30). Management may have been prompted to select methods which reduced the trading loss (for example by not reporting abnormal items and reporting an extraordinary item that did not recognize losses from the acquisition of Sunshine Australia Ltd).Taxes, political costs (government intervention) and regulations imposed by state or commonwealth authorities further contribute to the accounting choices made. In an attempt to avoid paying high taxes, or in anticipation of receiving or not losing available government incentives, management would tend to favour accounting techniques that would for example reduce profits (Whittred and Zimmer, 1988, pp. 34-38).Professional and Statutory Accounting StandardsProfessional and statutory bodies do recognize the availability of accounting choices. They have put in place requirements that increase disclosure of accounting methods used (through notes to the accounts) and reduce the choices of accounting methods.Further to this 'self-regulatory' measure, Schedule 7 paragraphs 8(1)(b)(vii) and (d) requires the accounts to include notes detailing components of the abnormal items and extraordinary items. Section 269(7) requires directors to ensure that reasonable steps have been taken in writing off bad debts and making adequate provisions for doubtful debts. There are no requirements that such write-offs and provisions are to be made.AAS1 and Schedule 7 only require separate identification of abnormal and extraordinary items, if they occur. In some instances management is in a...

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