RIPHA INTERNATIONAL UNIVERSITY ISLAMABAD

Al-Maizan Campus

MS – Accounts & Finance

Final Exam - Solution
Issues Financial Reporting
Hafiz Sajjad Rasheed
SAP ID # 19758
By: Professor Aman Ullah Khan

Question # 01

While making financial statements most of the time actual facts and accurate information is used
for example sales, purchases, payroll expenses etc. However, some items are measured using
estimates because there precise usage cannot be predicted and an estimate is the best assumption
about the use of the item.
Example
For example, a company buys a car and intends to use it for 5 years and depreciates it over 5 years.
However, if the car has a serious accident and cannot be used it wouldn’t be depreciated over 5
years and rather would be written off immediately. So the depreciation expense becomes an
estimate and not a fact.
Accounting estimate is an approximation of the amount to be charged debited or credited for
those items for which there is no precise means of measurement are available. These only based
on specialized knowledge and judgment derived from experience and training. They are used in the
financial statements to determine the carrying amounts of assets and liabilities and the associated
income or expense for the period where such amounts cannot be measured with precision and
certainty.
Examples of accounting estimates include:
• Useful life of non-current assets
• Impairment of non-current assets
• Bad debts
• Provision for obsolete and slow-moving stock
• Revalued amounts of non-current assets
• Provision for pension benefits
• Depreciation
 1. Recoverable Amount
Recoverable amount is the amount which is greater of an asset's fair value less costs to sell,
or its value in use. Value in use refers to the present value of future cash flows expected to
be derived from an asset. Thus, the concept essentially focuses on the greatest value that
can be obtained from an asset, either by selling or using it. The recoverable amount concept
is used in the international financial reporting standards framework. Sometimes, we acquire
an asset but due to some issues whether legal, political, financial or technological, the asset
cannot be used as it was intended. For example, an asset was purchased for production of
specific product. However, after the acquisition of the asset the government bans the
production of such product. Now the asset cannot be used as intended by the company.
Therefore, the asset’s recoverable amount is determined.
2. Impairment of Asset
Asset impairment occurs when the net carrying amount, or book value, cannot be
recovered by the owner.
An impaired asset is an asset valued at less than book value or net carrying value.
An asset is impaired if its projected future cash flows are less than its current carrying value.
An asset may become impaired as a result of materially adverse changes in legal factors that
have changed the asset’s value, significant changes in the asset’s market price due to a
change in consumer demand, or damage to its physical condition.
Another indicator of potential impairment occurs when an asset is more likely than not to
be disposed prior to its original estimated disposal date.

Question # 02

Income smoothing is the process moving of revenue and expenses among various
accounting periods to present the false impression that a business has consistent earnings. The
Management of the company takes part in income smoothing to expend profits in periods that
would have abnormally low income. The activities taken to take part in income smoothing are not
generally illegal; in some cases, the room permitted in the accounting standards allows
management to defer or accelerate certain items.
For example, the contingent liabilities, the allowance for doubtful accounts can be
manipulated to alter the bad debt expense from period to period. In other cases, the accounting
standards are clearly being sidestepped in an illegal manner in order to engage in income
smoothing.
Purpose of income smoothing

1. Reduce corporate tax

 For example if a corporate tax rate is 30% so if the company income is high then it would
bear a heavy tax but to reduce the tax management shifts income to next period or create
expenses high through provisions, that will help to reduce income.
2. Investors’ Attraction
Investors looking for, a stable return from their investment, for example, through profits or
interest payments, as to put their investment in those organizations which have stable
returns.

3. Management strategy
For business arranging purposes including planning, it is more useful to create consistent
income that will permit directors to get ready for development. It would be a lot harder to
legitimize purchasing new apparatus or recruit extra staff if each quarter produces
unpredictable benefits or misfortunes.

Methods use for income smoothing

a) Channel Stuffing
It is practice in which a company shipping goods to distributers and retailers through
distribution channel. In this way sales figures inflated. And there is no inquiry for income
smoothing by this way.
b) Big bath phenomenon
In this way management manipulating the income statement to make the results poor even
look worse. It is unethical accounting tactic in which income in a bad year look worse than it
actually is.
For example, company A speculates that it may fail the stock markets, this is forecast for
the current period and the management increases their loss to 40,000 from 20,000. They
will do this by for example writing off 10,000 as outmoded asset and increase their
depreciation to an additional of 10,000. This enables the company to indicate a profit of
20,000 in the coming financial Year which in turn shows investors and clients that the
company is doing well.
c) Provision of contingent liabilities
Thorough provisions management creates different provision to increase the expenses and
reduce the income. For example provision for employee retirement benefits, workers
welfare funds etc.
d) Cash flow management
 One tactic is to contrast the reported profit for a company with the cash flow. If the profit
earned is fine but exist a net cash flow then the company is employing creative accounting.
In case the company contains an ever-cumulating profit, cash flow at all-time cannot be
noted, hence the company results to book entries to manipulate and increase profits. In this
way the company’s owners feel confident that there are stable earnings hence improved
relationships among the investors, management, and the employees.

Question # 03

1- Introduction

Cash Accounting Concept

Cash Accounting is the simplest method of recording business transactions, as only those expenses
were recorded which were paid off. Similarly revenue is recorded on the basis of its receipts. There
is no concept of receivables and payables. The users of financial statements are interested in the
health of a company. Usage of cash accounting usually overstates the health of a company as it
might state a loss making company as a profitable business opportunity to invest in.

Financial reporting

In Financial reporting standard accounting polices & procedures are adopted to provide precise
depiction of a company’s finances, including its revenues, expenses, profits, capital & cash flows
which are essential for users of financial statements. Financial reporting helps the users to form
their opinion about the company’s health and whether they should invest in such a business or not.

2- Evolution from Basic Cash Accounting to Modern Financial Reporting and Social construct.

The environment of any organization has a direct impact on the quality of accounting polices &
procedures it is applying. Accountancy has its roots in the earliest history of civilization. With the
rise of agriculture and trade, people needed a way to keep track of their goods and of transactions.
In start cash accounting method was adopted by many small and medium sized entities for
recording day to day transactions of their business. The Industrial Revolution in the late eighteenth
and early nineteenth centuries, accounting developed further and users of financial statements
realized that for their decision making they need to update their accounting method that is being
applied consistently. The practice of financial reporting became dominant as business owners and
managers sought to understand how best to make their businesses as cost efficient, reliable and
accurate, as possible. With the new complexity of accounting and the increasing demand for
accurate bookkeeping, international Accounting bodies were formed such as the Financial
Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) are
considered as the creators of accounting standards in order to provide a solution for business for
the implementation of accurate accounting principles and polices that suites most of the
businesses. Modern financial reporting helped in understanding the objectives of financial
statements as to whether financial statements are presented fairly and are in conformity with
worldwide Generally Accepted Accounting Principles (GAAP), whether the financial position, results
of operations, and other changes in financial position are indicating a plus factor for the
organizational growth.

Modern financial reporting has helped the organizations to evaluate its strengths and weakness,
Show its investment and financing, evaluate its ability to meet its commitments and foremost show
its resource base for growth. Further Modern financial reporting aided in

(a) Relevance, which means selecting the information most likely to aid users in their economic
decisions.

(b) Understand-ability, which implies not only that the selected information must be intelligible but
also that the users can understand it.

(c) Verifiability, which implies that the accounting results may be corroborated by independent
measurers using the same measurement methods.

(d) Neutrality, which implies that the accounting information is directed towards the common
needs of users rather than the particular needs of specific users.

(e) Timeliness, which implies an early communication of information to’ avoid delays in economic
decision-making.

(f) Comparability, which implies that differences should not be the result of different financial
accounting treatments.

(g) Completeness, which implies that all the information that ‘reasonably’ fulfills the requirements
of other qualitative objectives should be reported.

Question # 04

Accounting as a language
Accounting has been perceived as the language of business. It is one means of communicating
information about a business. The perception of accounting as a language IS emphasized in most
popular accounting.
As the language of business, accounting has many things in common with other languages. The
various business activities of a firm are reported in accounting statements using accounting
language, just as news events are reported in newspapers in the English language. To express an
event in accounting not only does one run the risk of being misunderstood but also risks a penalty
for misrepresentation, lying or perjury. Comparability of statements is essential to the effective
functioning of a language whether it is in English or in Accounting. At the same time, language has
to be flexible to adapt to a changing environment.
This impression of bookkeeping as a language is likewise perceived by the bookkeeping calling,
which distributes bookkeeping wording notices. It is recognized in the experimental writing, which
endeavors to gauge the correspondence of bookkeeping ideas.
What makes bookkeeping a language) To respond to this inquiry, let us take a gander at the
expected equals among bookkeeping and language. Hawes characterizes a language as follows:
Man's images are not arbitrarily masterminded signs which lead to the conceptualization of
secluded and discrete referents. Maybe, man's images are masterminded in a deliberate or
designed style with specific guidelines overseeing their utilization. This game plan of images is
known as a language, and the guidelines which impact the designing and utilization of the images
establish the sentence structure of the language.
This definition and others show that there are two parts of a language, to be specific images and
linguistic standards. Accordingly, the acknowledgment of bookkeeping as a language lays on the ID
of these two parts as the two degrees of bookkeeping. It very well might be contended as follows:
The images or lexical attributes of a language are the 'significant' units or words recognizable in any
language. These images are etymological items used to recognize specific ideas. Emblematic
portrayals do exist in bookkeeping for example.
McDonald argues that a theory must have three elements:
 encoding of phenomena to symbolic representation.
 manipulation or combination according to rules.
 translation back to real-world phenomena.

Accounting is perceived as the language of business

According to Hawes, a language has two components, being symbols and grammatical rules:
 numerals and words and debits and credits are examples of the symbols unique to accounting
 in accounting, grammatical rules refer to the general set of procedures used
 Accounting records provide a history of the manager’s stewardship of the owner’s resources.
 Measurement of the stewardship concept has evolved over time, in the following periods:
 Pure custodial period.
 Traditional custodial period.
 Asset utilization period.
 Open-ended period.
The first two periods refer to the need for the agent to return the resources intact to the principal
by performing minimal tasks to fulfill the custodial function. In these periods, the disclosure of
balance sheet data was considered to be adequate.
The third period refers to the need for the agent to provide initiative and insight in using the assets
to conform to agreed plans. In addition to the balance sheet, this period requires the acquisition of
performance evaluation data on the effectiveness of the use of the assets.

Finally, the open-ended period differs from the asset utilization period by providing more flexibility
in the use of the assets and allowing the agent to chart the course of asset utilization.

Barenberg elaborates on this last concept:

This involves not only the initial direction, but also ascertaining the critical point in time when such
directions must be changed. Like strategic control, the stewardship function requires that a
significant degree of responsibility be assumed by the servant. The task force is probably
characterized by a lack of structure and a significant amount of uncertainty.
This suggests that we may find our reporting system to the master caught between the rock and
hard place of communication. The need for the detail on one hand and the risk of overload and
excessive complexity on the other.

Question # 4 Part-B

Theory construction and verification

Although accounting is a set of techniques that can be used in specified fields, it is practiced within an
implicit theoretical framework composed of principles and practices that have been accepted by the
profession because of their alleged usefulness and their logic. These 'generally accepted accounting
principles' guide the accounting profession in the choice of accounting techniques and in the preparation of
financial statements in a way considered to be good accounting practice. Present generally accepted
accounting principles are the result of an evolutionary process that can be expected to continue in the
future. Changes may occur at any level of generally accepted accounting principles ... Generally accepted
accounting principles change in response to changes in the economic and social conditions, to new
knowledge and technology and to demands of users for more serviceable financial information. The dynamic
nature of financial accounting -its ability to change in response to changed conditions enables it to maintain
and increase the usefulness of the information it provides
A theory should be subject to a logical or empirical testing to verify its accuracy. If the theory is
mathematically based, the verification should be predicted based on logical consistency. If the theory is
based on physical or social phenomena, the ver-ification should be predicted based on the relationship
between the deduced events and observations in the real world. Accounting theory, therefore, should be
the result of both a process of theory construction and a process of theory verification. A given accounting
theory should explain and predict accounting phenomena: when such phenomena occur, they should be
regarded as verification of the theory

the art of recording, classifying, and summarizing, in a significant manner and in terms of money,
transactions and events which are, in part at least, of a financial character, and interpreting the results
thereof. More recently, accounting has been defined with reference to the concept of information - that is,
accounting is a service activity. Its function is to provide quantitative information, primarily financial in
nature, about economic entities that is intended to be useful in making economic decisions, in making
reasoned choices among courses of action.2 These definitions refer [Q accounting as either an 'art' or a
'service activity' and imply that accounting encompasses a body of techniques deemed useful for certain
fields. These images are accounting as an ideology, accounting as a language, accounting as a historical
record, accounting as a current economic reality, accounting as an information system and, finally,
accounting as a commodity.

Question # 05
I agree with the author viewpoint and start my viewpoint with this sentence that the people all
over the world are affected on a daily basis by the actions of people they never met. So this
includes individuals who contribute to the retirement funds, investment in stock market or beware
a company stockholder in some other way. Accounts they make vital contributions to the world
economy and the ethical obligations that they have readily apparent.

Now I mention some limitations of financial reporting that includes:

i. Different accounting policies and framework e.g U.S GAAP & IFRS two different sets of
framework adopted by accountants worldwide.
ii. Presence of subjectivity: it means there are many accounting g estimates which needs
human judgment and inherently subjective rather than objective. Accountants used
subjectivity to show higher profits.
iii. Reward of monetary values: it gives the effectiveness and skills of our employee’s i.e
qualitative aspects of the organization.
iv. Limited predictive values: it based on the historical values or past events and does not
show futuristic value.
v. It is not absolutely free from frauds and errors
vi. There is also hope of compromises because we show benefits more and the cost less. The
damage of dishonest amounting goes beyond the white collar crimes. Most people affect
significantly if they are not aware by the work of accountants in a globalized markets of
today the shared complexity of corporate dealings demands accountants act fair and
transparent manner. This entails accurate assessment of liabilities and assets involved in the
massive transactions..
Example
I quote a recent example our despite being the most regulated profession.
a) AOB has panelized KPMG Pakistan for sugar audits. KPMG fined 3.5 Million leading
partner of Lahore office and suspended for one year and reprimand has been issued
to the firm”
b) The Major frauds occurs in the world companies are
 World com telecommunication firm
 ENRON scandal
 Freedie Mac – Mortgage Corporation
 Tyco - security based company
We conclude that emphasis should be given to ethical standards and professionalism and
quality of information provided in the financial statement rather than rule based
accounting.