Financial Reporting Essay Research Paper OnSeptember 28

Financial Reporting Essay, Research Paper

On

September 28, 1998, Chairman of the U.S. Securities and Exchange Commission

Arthur Levitt sounded the call to arms in the financial community. Levitt asked

for, "immediate and coordinated action. to assure credibility and

transparency" of financial reporting. Levitt.s speech emphasized the

importance of clear financial reporting to those gathered at New York

University. Reporting which has bowed to the pressures and tricks of earnings

management. Levitt specifically addresses five of the most popular tricks used

by firms to smooth earnings. Secondly, Levitt outlines an eight part action plan

to recover the integrity of financial reporting in the U.S. market place. What

are the basic objectives of financial reporting. Generally accepted accounting

principles provide information that identifies, measures, and communicates

financial information about economic entities to reasonably knowledgeable users.

Information that is a source of decision making for a wide array of users, most

importantly, by investors and creditors. Investors and creditors who are

responsible for effective allocation of capital in our economy. If financial

reporting becomes obscure and indecipherable, society loses the benefits of

effective capital allocation. Nothing illustrates the importance of transparent

information better than the pre-1930.s era of anything goes accounting. An era

that left a chasm of misinformation in the market. A chasm that was a

contributing factor to the market collapse of 1929 and the years of economic

depression. An entire society suffered the repercussions of misinformation.

Families, and retirees depend on the credibility of financial reporting for

their futures and livelihoods. Levitt describes financial reporting as, a bond

between the company and the investor which if damaged can have disastrous,

long-lasting consequences. Once again, the bond is being tested. Tested by a

financial community fixated on consensus earnings estimates. The pressure to

achieve consensus estimates has never been so intense. The market demands

consistency and punishes those who come up short. Eric Benhamou, former CEO of

3COM Corporation, learned this hard lesson over a few short weeks in 1996.

Benhamou and shareholders lost $7 billion in market value when 3COM failed to

achieve expectations. The pressures are a tangled web of expectations, and

conflicts of interest which Levitt describes as "almost

self-perpetuating." With pressures mounting, the answer from U.S. managers

has been earnings management with a mix of managed expectations. March of 1997

Fortune magazine reported that for an unprecedented sixteen consecutive

quarters, more S&P 500 companies have beat the consensus earnings estimate

than missed them. The sign of a quickly growing economy and a measure of the

importance the market has placed on consensus earnings estimates. The singular

emphasis on earnings growth by investors has opened the door to earnings

management solutions. Solutions that are further being reinforced to managers by

market forces and compensation plans. Primarily, managers jobs depend on their

ability to build stockholder equity, and ever more importantly their own

compensation. A growing number of CEO.s are recieving greater percentages of

their compensation as stock options. A very personal incentive for executive

achievement of consensus earnings estimates. Companies are not the only ones to

feel the squeeze. Analysts are being pressured by large institutional investors

and companies seeking to manage expectations. Everyone is seeking the win.

Auditors are being accused of being out to lunch, with the clients. Many

accounting firms are coming under scrutiny as some of their clients are being

investigated by the SEC for irregularities in their practice of accounting.

Cendant and Sunbeam both left accounting giant Arthur Anderson holding a big

ol.bag full of unreported accounting irregularities. Auditors from BDO Seidman

addressed issues of GAAP with Thing New Ideas company. The Changes were made and

BDO was replace for no specific reason. Herb Greenberg calls the episode,

"A reminder that the company being audited also pays the auditors.

bill." The Kind of conflict of interests that leads us to question the idea

of how independent the auditors are. All of these pressures allow questionable

accounting practices to obfuscate the reporting process. Generally accepted

accounting principles are intended to be a guide, not a procedure. They have

been developed with intended flexibility so as not to hinder the advancement of

new and innovative business practice. Flexibility that has left plenty of room

for companies to stretch the boundaries of GAAP. Levitt focus.s on five of the

most widespread techniques used to deliver added flex

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