978-0077862213 Chapter 8 Solution Manual Part 1

Unlock access to all the studying documents.

View Full Document

Chapter 8 Discussion Questions

1. In this chapter we discuss problems encountered by the PCAOB in gaining access to inspect work

papers of audits by U.S. international accounting firms of Chinese companies. Explain why these problems

exist including cultural, legal, and ethical considerations.

Gray uses Hofstede’s values to identify accounting values of professional, uniformity, conservatism, and secrecy.

China shows a preference for statutory control and compliance driven prescriptive legal requirements versus a

preference for professional judgment; uniformity and consistency across companies in the use of accounting

practices versus choice of accounting practice with perceived circumstances of individual companies; high

conservatism, a tendency to defer the recognition of assets and items that increase net income while reserving for

In the ethics reflection we discussed the case of Longtop Financial Technologies and Deloitte & Touche. Deloitte

has been caught up in a critical issue regarding the role of Chinese accounting firms that review the financial

The S.E.C. began investigating Longtop Financial Technologies of China for accounting fraud in 2011 after

Deloitte’s Chinese affiliate resigned as its auditor because of significant problems in verifying its financial

Deloitte issued a clean opinion on Longtop’s financial statements through 2010 and only withdrew its audit opinions

in May 2011 when it resigned. In its letter to the company, Deloitte said it found “very serious defects” that included

The first step in any corporate financial fraud investigation is to obtain the work papers of the auditors, so the S.E.C.

issued a broad subpoena to Deloitte’s Chinese affiliate for those records within days of its resignation. The

misconduct disclosed in the resignation letter raises questions not only about Longtop’s management but also how

The firm has resisted complying with the subpoena because it asserted that turning over its work papers could

In September 2011, the S.E.C. filed a subpoena enforcement action in Federal District Court in Washington to force

Deloitte’s Chinese affiliate to turn over the documents from its Longtop audits. The S.E.C. argued that it should be

If the court orders the accounting firm to turn over the records and it refuses, then it can be held in contempt under

The firm could also face suspension or revocation of its registration as an auditing firm in the U.S. by the PCAOB if

The issue of whether Chinese accounting firms meet the standards set in the U.S. is a growing concern. The PCAOB

Deloitte’s Chinese affiliate is in a difficult position because the S.E.C. is unlikely to back away from a case in which

American investors suffered losses based on what appears to be a rather brazen accounting fraud. And the Chinese

The bottom line issue in the Deloitte – Longtop case is legal and cultural considerations can and do influence the

2. What are the costs and benefits of establishing one set of accounting standards (i.e., IFRS) around

the world? How do cultural factors, legal systems, and ethics influence your answer? Apply a utilitarian

approach in making the analysis.

The advantages of one set of accounting standards to be followed by all companies around the world include the

comparability of financial statements, irrespective of the location of the company’s headquarters; global cost of

capital; and its ability to raise capital in world-wide markets, not just the home country. The disadvantages of one set

of accounting standards is the failure of one set of standards to be 100% compatible with the unique legal,

regulatory, litigious, social, economic, religious, and cultural environments of each country. There are some

Here is a more extensive list of advantages and disadvantages of adopting IFRS in the U.S. Any utilitarian

Advantages

Improved transparency. Investors, executives, and managers in different countries

should be able to better understand a foreign company’s or multinational’s reports and

statements.

Uniformity across international boundaries.

Disadvantages

Systems will need to be modified to accommodate new charts of accounts. There will

likely be a period for US companies of tracking and reporting in both GAAP and IFRS,

while also clarifying the variances between the two methods.

Education of accounting students in IFRS is lacking; burden placed on firm training

creates excessive costs

There will be changes to tax, technology, and valuation and these will vary from

country to country.

3. What are the fundamental principles of professional ethics for professional accountants identified by

the IESBA and included in the IFAC Code of Ethics? How do these principles relate to the proposed

standards for responding to suspected illegal acts in the IESBA exposure draft with respect to whistle-

blowing obligations of accountants and auditors?

The IFAC Code of Ethics includes the following fundamental principles:

(a) Integrity – to be straightforward and honest in all professional and business relationships.

(b) Objectivity – to not allow bias, conflict of interest or undue influence of others to override professional

or business judgments.

required to ensure that a client or employer receives competent professional services based on current

Under the IESBA exposure draft, a professional accountant who suspects some act or activity may be illegal would

be required to take reasonable steps to confirm or resolve the suspicion and to discuss the issue with the appropriate

The IESBA makes a distinction between an accountant and an auditor in terms of the expected response to

suspected illegal acts. An auditor would be required to pursue remedies up to and including contacting legal

authorities, but an accountant working either inside or outside the organization would be held to a slightly lower

The IESBA proposal seeks to strike a balance between confidentiality and the public interest. Auditors and

accountants are bound to confidentiality as one of the five fundamental principles in the IFAC Code, but they may

be required to set it aside when public interests are better served by disclosure of possible illegal actions. Criteria

4. The Institute of Chartered Accountants in England and Wales (ICAEW) has adopted a code of

ethics based on the IFAC Code. In commenting on the principles-based approach used in these codes, the

ICAEW states that a principles approach “focuses on the spirit of the guidance and encourage

responsibility and the exercise of professional judgment, which are key elements of professions.” Explain

what you believe this statement means.

In chapter 2 we noted that the principles in the AICPA Code are aspirational statements and guide members in

the performance of their professional duties; they call for an unyielding commitment to honor the public

interest, even at the sacrifice of personal benefits. The principles represent the expectations of the accountants

The IFAC Code sets out five fundamental principles, which guide members’ behavior:

Integrity

Objectivity

Professional competence and due care

The ethics code relies on professional judgment. The rules can never be expected to cover all situations encountered

by accounting professionals. When the rules are unclear, judgment must be used based on the principles in the code,

5. Consider the practice of making “facilitating payments” to foreign officials and others as part of

doing business abroad in the context of the following statement:

International companies are confronted with a variety of decisions that create ethical

dilemmas for the decision makers. “Right- wrong,” “just-unjust” derive their meaning and

true value from the attitudes of a given culture. Some ethical standards are culture-specific,

and we should not be surprised to find that an act that is considered quite ethical in one

culture may be looked upon with disregard in another.

Explain how culture interacts with the acceptability of making facilitating payments in a country. Use

Rights Theory and Justice reasoning to analyze the ethics of allowing facilitating payments such as under

the FCPA in the U.S. and prohibiting them as under the U.K. Bribery Act.

For legal purposes, a facilitating payment is distinguished from bribery; however, the distinction is often

blurred. Determining whether a payment is a facilitating one may be difficult and depend on the circumstances.

The value of the payment is not immediately relevant; however, the greater the value, the higher are chances

As of 2006, the United Kingdom does not recognize the legality of facilitating payments and does not draw any

distinction from bribes. However, the UK is unlikely to prosecute for minor facilitating payments in the areas where

it is a common practice. Within the U.S. federal legislation, a facilitating payment or “grease payment”, as defined

by FCPA is a payment to a foreign official, political party or party official for “routine governmental action,” such as

Using Rights Theory, the categorical imperative would imply that if a bribe or facilitating payments is wrong in one

culture, then it is wrong in all cultures. The imperative would also imply that if a facilitating payment is just an

immaterial bribe, then it is a bribe also. The U.K. Bribery law is using reasoning in accordance with rights theory.

Using Justice Theory, a just act respects your rights and treats you fairly. The most fundamental principle of justice

6. Do you believe that “one size fits all” with respect to corporate governance provisions in different

countries around the world? Why or why not? How do legal and cultural factors influence corporate

governance provisions in the U.S., Germany, China, and India?

Ethical issues exist in corporate governance systems in different countries because of legal system, business

practices, and cultural considerations that directly affect the way in which companies are managed and controlled.

Research shows that investor protection differs significantly among countries. In common-law countries (i.e., United

States and United Kingdom), the legal systems are not dependent on comprehensive compilation of legal rules and

A country’s culture may be another factor that influences corporate governance. Research shows that the

prevalence and level of private benefits of control (used as a direct proxy for investor protection) is also influenced

by cultural norms within a country and not solely a result of low investor protection. In addition to legal mechanisms

China is a good example of legal and cultural differences influencing corporate governance. The Chinese

government, that is a major shareholder of state-owned enterprises, has a history of keeping information about the

In Germany, the dual board system creates a stumbling block to common corporate governance systems with the

U.S. unitary approach. How can we reconcile using the management board to prepare and be responsible for the

7. Describe the different kinds of reserves that can be recorded. How do the reserves relate to the

discretionary accruals discussed in Chapter 7? Can the accounting for reserves lead to a manipulation of

earnings? Do you believe it would be more or less prevalent under IFRS or GAAP?

In the U.S., the word reserves means provision which in turn can mean (1) a liability of uncertain time amount and

(2) an allowance against or impairment of the value of an asset. Such a liability relates to situations that do not exist

at the reporting date, such as contingencies. An example of such an allowance is the uncollectibles account and

8. Critics of the IFRS argue that the more principles-based IFRS is not as precise and therefore is

easier to manipulate than the more rules-based U.S. GAAP. The reason being is that IFRS requires more

professional judgment from both auditors and corporate accountants with regard to the practical

application of the rules. The application of professional judgment opens up the door to increased

opportunities for earnings management. Do you agree with these concerns expressed about principles-

based IFRS? Relate your discussion to the research results discussed in this chapter.

IFRS are considered principles-based and allow for professional judgment to be applied. The standards are more

flexible in dealing with all economic and business situations. Some might argue that allowing that much judgment

introduces bias. U.S. GAAP is considered rules-based or more prescriptive. Many feel that this tightens up

To determine if there was a difference in the magnitude of earnings management in a principles- based versus

rules-based environment, Mergenthaler examined the factors that executives consider when deciding to manage

earnings. He contends that the probability of being penalized for earnings management and the penalty imposed on

executives who manage are factors that influence executives’ estimate of the expected cost of earnings management.

French authors Thomas Jeanjean and Herve Stolowy examined the effect of IFRS conversion on earnings

quality—specifically on management manipulation of earnings to avoid recognition of losses. Their work examined

more than 1,100 firms in three countries to determine whether the earnings management appeared to increase or

decrease after implementation of IFRS. The authors measured financial reporting quality as a reduction in earnings

A frequent question asked is whether principles-based accounting standards increase or decrease earnings

informativeness. As outlined in the SEC study and the FASB report on the principles-based approach, some argue

that earnings are more informative when standards are principles based. They contend that principles-based

standards do not have bright-line thresholds or exceptions that allow managers to structure transactions that

In a study of principles-based standards and earnings effects, Folsom et al. examined whether the reliance on

principles-based standards affects the informativeness of earnings. They defined principles-based standards as

standards that have fewer rules-based characteristics than rules-based standards, as evidenced by fewer bright-line