IAS INDUSTRY ACCOUNTING STANDARDS

Look For Violations

Be Cautious

Industry Analysts – Be Cautious

•Recent accounting scandals highlighted importance of banker’s confidence in the accuracy and lack of distortion of accounting data•health of a bank’s loan portfolio

Industry Analysts – Be Cautious

•The legal and moral culpability of top-level company managers (as well as auditors) is an issue

•Why do some companies distort accounting numbers as well as engage in other actions that damage the interests of company stakeholders, such as stockholders, banks, employees, and the community?

Signs of Misleading Financial StatementsAffecting All Industries

MANAGEMENT DECISION

Choosing accounting policies

Changing accounting policies

Deferring expenses

Income smoothing

Recognizing revenue too soon

BANKER’S CONCERN

Too liberal

Unjustified

Profits are overstated

Profits are understated

Profits are overstated

tres

MANAGEMENT DECISION

Expense is under accrued

Expense is under accrued

Expense is over accrued

BANKER’S CONCERN

Profits are overstated and Expenses are understated

Profits overstated and Liabilities understated

Profits understated and Liabilities overstated

Signs of Misleading Financial StatementsAffecting All Industries

Signs of Misleading Financial StatementsAffecting All Industries

MANAGEMENT DECISION

Changing discretionary cost

Low quality controls

Change in auditors on a frequent basis

BANKER’S CONCERN

• Manipulation profits

• Risk of financial statement manipulations

• Risk of financial statement manipulations

Red Flags

Cash A portion is restricted Currency uncertainty divisional levels

Receivables Large overdue receivables Large increase with sales flat Overly dependent on one or two customers Related-party Receivables Slow Receivables turnover Right of return exists

Red Flags

Uncollectibility of Receivables Warning Signs Large amount of overdue Receivables Large increase in Receivables with flat

sales Exaggerated dependence on one or two

customers Receivable Check List

Watch and work the ACP Business dispute with customer

Red Flags

Receivable Check List Watch "channel stuffing" making last minute sales to distributor

just before quarters end. Change one bad asset for another Growth companies feel pressure to book

sales no matter to whom Concentration vs. diversification

Early Warning Signs on the Balance Sheet

Inadequate Salability of Inventory Warning Signs

Change of corporate inventory valuation methods

Increase in the number of LIFO pools Inclusion of inflation profits in inventory Large, unexplained increase in

inventory Inclusion of improper costs in inventory

Early Warning Signs on the Balance Sheet

High inventory of high tech products can be disastrous because improved products hit the market every 6 to 24 months

Who wants a Verizon cell phone six years old?

Watch Inventory turnover

Watch Faddish Inventory

Early Warning Signs on the Balance Sheet

Fixed Assets Warning Signs Old equipment and technology Cash flow signals High maintenance and repair expense Declining output level Inadequate depreciation charge

Early Warning Signs on the Balance Sheet

Investments Watch Realization Switching between current and

noncurrent categories Investments recorded in excess of costs Risky investments that must be written

off

Early Warning Signs on the Balance Sheet

Overstatement of Intangibles Warning Signs

Slow amortization period Lengthening amortization period High ratio of intangibles to total

assets and capital Large balance in goodwill even

though profits are weak

Warning Signs: Liabilities and Equity

Liabilities Watch Understated Amortize warranties quickly Arbitrary adjustments Smoothing

Warning Signs: Liabilities and Equity

Equity Treasury Stock - large and frequent

transactions Large and unreasonable dividends Unexpected and/or substantial reserves Worrisome negative cumulative

translation adjustments

Example of Airline Industry Financial Reporting

• Accounting Policy Task Force (IATA) (APTF) of the International Air Transport Association (IATA) has issued a number of Airline Accounting Guidelines and liaises with standard setting bodies on issues for the industry.

• Translation of Long Term Foreign Currency Borrowings • Frequent Flyer Program Accounting • Components of Fleet Acquisition Cost and Associated

Depreciation • Recognition of Revenue • Accounting for Maintenance Costs • Accounting for Leases of Aircraft Fleet Assets • Segmental Reporting

Mining Industry Financial Reporting

• The mining industry includes thousands of companies engaged in mining an array of products including precious metals, base metals, coal, uranium, and other industrial minerals▫Accounting for and Disclosure of Mineral Reserves

How should the costs of acquiring mineral rights or properties be accounted for given these acquisitions may take the form of taking title to properties, obtaining mineral and mining rights, leases, patents, etc.

How should generally accepted principles for determination of the impairment of such costs capitalized be determined?

What financial information should be disclosed to investors that will provide relevant, comparable and transparent disclosures of mineral reserves?

Mining Industry Financial Reporting

Accounting for costs associated with exploration and development activities Clarify that costs incurred in exploring

for minerals may not be capitalized. Provide definitions of exploration

activities (related costs are expensed) versus mine development activities (related costs are capitalized).

Mining Industry Financial Reporting

•Accounting for development activities performed contemporaneous to production ▫Specify that costs incurred at an operating

mine, excluding costs included in inventory, should not be deferred.

▫Provide guidance as to when a mine is under construction versus in production.

▫Due to the nature of the business, specify which, if any mine development costs incurred prior or subsequent to commercial production commencing, should be capitalized.

Mining Industry Financial Reporting

Accounting for operating activities Define when it would be appropriate for

inventories of precious and base metals appropriately to be recorded at other than cost.

Provide guidance about common revenue recognition matters unique to the industry.

Income Statement Issues Affecting All Industries

•Cost and Equity Method▫Cost method

The original investment is recorded at cost in an investment account. Additions to the original investment also recorded at

cost in the investment account. Dividends received out of accumulated earnings prior

to acquisition are recorded as a return of investment. All other dividends are recorded as dividend income.

The recording of dividends as dividend income is the major difference between the cost and the equity methods.

Income Statement Issues

Cost and Equity Method Equity method

▪ This method is exactly the same as the cost method except:▪ Dividends received are credited to the investment

account and are not considered income▪ The investor periodically records its share of the

investor's net income by a debit to the investment

account and a credit to income from subsidiary

Example: Cost Method Of Recording Investments

INVESTMENT IN XEROX (10%)

Debit Credit

Investment in Nerox

$700,000

Cash $700,000

COST METHOD

Record

dividends

when declar

ed

• No accounting distortions

Income of

investment

is ignore

d

• No accounting distortions

Adjust investment book value

of value depreciates

• No accounting distortions

Example: Cost Method Of Recording Investments

WHEN DIVIDENDS ARE DECLARED THE CASH ACCOUNT RECORDS A $36,000 INCREASE AND THE INCOME STATEMENT RECORDS $36,000 DIVIDEND INCOME:

Debit Credit

Cash $36,000

Dividend Income

$36,000

COST METHOD

Record

dividends

• No accounting distortions

Income of

investment

is ignore

d

• No accounting distortions

Adjust investment book value

of value depreciates

• No accounting distortions

Example: Equity Method Of Recording Investments

INVESTMENT IN NEROX (25%)

Debit Credit

Investment in Nerox

$1,000,000

Cash $1,000,000

EQUITY METHOD

Record pro rata

share of

profits

• Likely accounting distortions

Record

Dividends

• No accounting distortions

Adjust investment book value

of value depreciates

• No accounting distortions

Example: Equity Method Of Recording Investments

ON DECEMBER 31, 2007, NEROX RECORDS A PROFIT OF $1,000,000. WE RECORD 25% OF THAT INCOME INTO OUR FINANCIAL STATEMENT:

Debit Credit

Investment In Nerox

$250,000

Equity Earnings In Unconsolidated Subsidiary

$250,000

EQUITY METHOD

Record Pro Rata Share

Of Nerox Incom

e

• Likely accounting distortions

Record

divicends

• No accounting distortions

Adjust investment book value

of value depreciates

• No accounting distortions

Example: Equity Method Of Recording Investments

ON DECEMBER 31, 2007, NEROX DECLARES A $100,000 DIVIDEND SENDING A CHECK OF $25,000 TO US, THE INVESTOR.

Debit Credit

Cash $25,000

Investment In Nerox

$25,000

EQUITY METHOD

Record

dividends

• No accounting distortions

Record

dividends

• No accounting distortions

Adjust investment book value

of value depreciates

• No accounting distortions

Important Issues In Accounting

Restructuring Charges; How and Why?

Gains and Losses on Sale of Businesses

Tie into Gains/Losses on Sale of Equipment

Deferred Tax Credits

Amortization of Bond Premiums

Amortization of Bond Discounts

Contingencies

Risk of catastrophic losses Direct and indirect guarantees Financial instruments with off

balance sheet risk Recourse obligations on Receivables

or B/R's sold Securitization of assets Futures contracts Pensions

Contingencies

Risk of catastrophic losses Direct and indirect guarantees Financial instruments with off

balance sheet risk Recourse obligations on Receivables

or B/R's sold Securitization of assets Futures contracts Pensions