Accounting

World has changed means that in the modern world the accounting  auditing standards and practices have become more stringent requiring the controllers (companys management) and the auditors to present compliance to those standards and practices. These revised accounting standards require more detailed and extensive disclosures for amounts appearing in the financial statements of a company. The modern world practices has also brought in more established and modernized audit practices requiring an auditor to carry out their work critically and objectively, while incorporating a sense of unpredictability in their work when carrying out audits. This includes using audit techniques and methods established to verify the accuracy of the amounts that assist the auditor in their work.
Further, several audit techniques and tools have been established to help the auditors in identifying the red flags during the audit. Involvement of the forensic experts, fraud risk examiners (with the companys consent), SOX and COSO requirements regulating the controls of an entity make it difficult for perpetrator to commit any type of financial statement fraud.
Q15
 True and fair view states that the amounts and the information presented in the financial statements are factual, the transactions were actually entered in to, the assetsliabilities reported in the financial statements exist and are disclosed and valued properly and are in conformity with the accounting records maintained by the company prepared in accordance with the accepted accounting principles.
 Present fairly encompass presentation of information and amounts in the financial statements that is in accordance with the accounting principles and standards as referred to in expression, true and fair view.
Both the above statements recognize situations in which there may be events or transactions that are not addressed by any specific standard or accounting principle, in such circumstances the said event or transaction shall be dealt under an accounting standard or principle that deals with similar events or transaction under the given circumstances.
The underlying concept in both the statements revolves around the applicability of an acceptable framework to the transactions entered by the entity supported by original books of accounts to evidence the occurrence of all such events and transaction, hence, there is no significant difference between the two statements.
Case 5-9
Q1
The deficiencies  amendments in the audit report are marked in square brackets  as under
Introductory paragraph
Line 1 retained earnings and cash flows for the year ended..
Scope paragraph
Line 1 and 2 in accordance with generally accepted auditing standards prepared by the American Institute of CPAs standards of the Public Company Accounting Oversight Board (United States)
Line 4 includes examining on a test basis, evidence supporting.
Line 6 significant estimates that we made made by management as well as.
Opinion paragraph
Line 1 present fairly in all material respects the financial position.   
Line 2 of its operations and its cash flows for the..
Line 4 and 5 principles established by the Financial Accounting Standards Board generally accepted in the United States of America.
Date of the audit report
The date mentioned on the audit report is the date of the year-end covered by the financial statements. However, the date of the audit report should not be earlier than the date on which the auditors of the company have gathered sufficient audit evidence to form a suitable basis for their opinion.
Q2
Though Miss Hawkins have been posted to another audit client but the principles of Professional Responsibility  in the AICPA Code of Professional Conduct does not restrict communication between members of the engagement team until the audit is finalized, i.e report is issued to the client.
Q3
Accounting issues that foster should have considered before making the statement would be
The inventory should properly valued in the financial statements i.e. all the items included in the inventory should be carried at the lower of the total cost and the price they are expected to be sold in the market (Net Releasable Value)
Materiality of the amount of the inventory as compared to financial statements taken as a whole.
Q4
Additional steps that could have been taken in the situation that inventory at Boston was never observed may include
Obtaining details relating to cyclic counts of the inventory performed by the management.
Performing steps to check any differences in the cyclic accounts and actual inventory have been identified and adjusted in a proper way.
Checking whether there is any formal plan for the counting of inventory on a periodic basis and inquiring from the management if it follows the program actively.
A qualified opinion would be appropriate given the fact that the auditor is unable to obtain sufficient evidence relating to the marketability of inventory. Given the limited facts, it is not clear if the amount of the inventory is material to the financial statements or if the inventory couldnt be counted due to auditors own negligence, therefore a qualified opinion would be appropriate. However if the amount of the inventory is material the auditor should disclaim an opinion .
Q5
If the audit report is issued without making any adjustments the firm of Johnson  Garson would be violating the following rules in the AICPAs code
Rule 501-4 Negligence in the Preparation of Financial Statements or Records
Rule 102-1 Knowing misrepresentations in the preparation of financial statements or records.
Rule 201 General standards (Due Professional Care and Sufficient Relevant Data)

The IASBs discussion paper on financial position presentation has generated considerable heat mainly due to the fact that such a document has considerable impact on the perceptions that is developed of business performance and affects investment decisions made by individual investors.  Controversy on the content of financial guidelines is a common accountancy occurrence and the discussion papers proposals have not been an exception.  This paper will look at some of the issues that are central to a heated debate with reference to the content of the statement of financial position and comprehensive income to determine their impact and potential course of action.

Discussion

High quality financial reporting is an issue that affects both individuals interested in investing in the financial markets and ordinary people within an economy.  The proposal presented in the discussion paper has especially raised a number of issues with respect to the implication that it has for financial service entities especially banks.  The proposal within the discussion paper relating to the classification of assets and liabilities should not be the case for financial service entities for it may cause a clash with the statement on paragraph 2.78 of the discussion paper which asserts that the source of profitability for such entities is management of financial assets and liabilities.  The assertion in the discussion paper that the benefits of the proposal outweighs the costs of preparing the suggested information by banks may also not be true if the role played by disclosure is considered.  Preparation and presentation of financial statement is a tiring task for financial department.  There are numerous requirements that have to be met in disclosure.  It is noteworthy that the cost of disclosure may vary considerable depending on the volume of financial transactions, the technology employed by a banking or financial institution and the time allocated for preparation of the financial records.  This is an issue that the proposal appears to have ignored in asserting that the cost of preparing and auditing the financial records is universally high.

The discussion paper develops an image that the IASB is developing regulations that are considerate of individual banking institutions financial and time resources.  While this may appear to be a positive move that could result in increased profitability, the risk involved in employing approaches that are less restrictive cannot be afforded by the banking sector.  Millions have over the years been lost due to accounting practices that were open to manipulation.  With this in mind, more emphasis should be placed on ensuring transparency rather than considering the financial and time resource used by financial institutions.  Focussing on financial entities expenses in developing the financial statements undermines the role of disclosure and should therefore be reconsidered.

One of the key issues is the assertion that there is a need in change of presentation of financial statement for financial service entities that should result in significant benefits with respect to the cost associated with making the changes.  A critical review of reporting and bookkeeping within financial service entities reveals that they currently have numerous guidelines and robust financial algorithms and ratios that are recognised internationally.  It is noteworthy that the proposal for change in presentation is being made without tangible evidence of failure of the current ratios.  Even though the impact of the global financial crunch has had its way with standards setters resulting in the need for re-examination of some of the existing practices, there is no evidence of a problem that can only be addressed with change in the primary financial statement.  The current presentation approach and ratios are appropriate for predicting cash flows among other important financial requirements.  The proposed financial statement presentation would results in complication of ratios used in analysing financial results which could potentially result in reduced transparency, comparability and comprehension.

A review of developments and changes made in financial reporting shows that financial crises and hardships have played a significant role.  Massive failure of the existing financial systems, infiltrations, unethical practices and failure of the existing practices to shield financial institutions from harsh economic times have historically played a role in changes in financial reporting.  The 2008 economic crisis has led to the realisation that the existing financial practices have some leaks that could have global implications.  A review of the 2008 economic crisis reveals that the problem originated from issues relating directly to the financial and book keeping approaches adopted by financial institutions and banks.  Failure of a system for instance the financial systems could be a result of collapse of a component or poor interaction between components.  The assertions that there is no need for change appears to be misguided in that though there is no direct link between the primary financial statement and economic crisis , the financial system were compromised thus calls for change are in order.

Another concern is that there is lack of meaningful definition of the distinction between the business and financing sections.  Moreover, categorisation between operating and investing is not clear.  The ISAB as a global entity has been developing guidelines used by financial institutions in bookkeeping and accounting.  It is noteworthy that a key requirement in developing guidelines is that they should be clear to avoid misunderstanding.  Clarity is a requirement that is shared by both guidelines and regulations which serves to assert its importance in financial reporting.  Clarity in defining the difference between potentially derogatory financial terms is required for consistent application of management approaches especially for banks.  The discussion paper does not clearly define these terms which may result in significant confusion on how common businesses functions of financial institution should be classified.  Since the discussion paper does not have a concise classification or categorisation of banking activities it makes such activities arbitrary which reduces comparability across banks.  It is noteworthy that the current categorisation of the cash flow items, comprehensive income items and financial positions items into operating, investing and financial activities may not be as helpful in defining practical banking and making decisions.  In cases where banks are required to make distinction between the activities, there is likely to be a reduction of comparability of financial information across the banking sector which may result in bookkeeping and accountancy practices that do not meet IASBs cohesiveness objective. 

Issues pertaining to clarity have for years considerably impacted on the guidelines developed by the IASB.  In fact a number of amendments in the guidelines have been a result of the need to clarify issues.  It is noteworthy that amendments are only necessary in a case where the guidelines have been put into action without the detection of unclear issues.  However, amending guidelines to ensure clarity before their implementation is a possibility that the IASB could consider before the discussion papers proposals are transformed to requirements that financial institutions have to conform to.

The discussion paper proposes the use of a management approach to categorised assets and liabilities.  Even though the approach may be effective in relaying the management intent in financial reporting, the discussion paper lacks sufficient information to assist financial service entities in categorisation.  The use of a management approach could result in inconsistency in reporting on a global scale.  It is noteworthy that though managers are better placed to translate financial documents, individual investors depend largely on comparability with other institutions.  It is noteworthy that comparability of financial statement enhances their characteristics in a qualitative dimension.  By reducing comparability of financial statement, the proposed management approach of categorisation would impede individual investors understanding of financial statements by reducing their ability to develop a clear picture of a firms financial performance relative to others and changes in financial positioning. 

A review of financial reporting reveals that even though one of the key objectives is management purposes relating to decision making and planning, another role is its importance to individual investors.  A financial statement is a document that helps organisations asses their performance within a given period (Stickney, Weil  Schipper 2009).  Reasons for improved or lacklustre performance are often based upon the financial statements.  Like any assessment tool, acceptability of the results is dependent on the usability of the tool by both the management and investors.  The use of a management approach which reduces individual investors ability to translate the results could lead to a situation where investors and management teams are at constant disagreement with respect to the financial positioning of firms.  This is a key undoing of the proposal for it undermines a goal in financial reporting. 

The management approach to categorisation of assets and liabilities could have a negative impact on the already ailing financial markets.  Investors confidence in the financial markets has been low due to instabilities and the global financial crisis.  In a financial environment where the risk of investment is considerably high, individual investors are less willing to commit their financial resources to ventures that they do not fully comprehend.  The management approach to categorisation of assets and liabilities would make every banking and financial institution subject to investors mistrust this would be detrimental considering that most banks need to develop their investment bases owing to the effects of the financial crisis.

Another concern is the need for transparency in presentation of certain important figures.  The presentation of realised and unrealised fair values gains and losses should be made more transparent (Basel Committee of Banking Supervision 2009).  It is noteworthy that the discussion paper in efforts to improve on transparency proposes that a schedule should be presented in the notes to financial statements.  The proposal would reconcile cash flows and disaggregate comprehensive income into four proponents.  It is evident that such a presentation would result in additional requirements thus increased complexity of financial statements.  As a rule of thumb, transparency has a form of indirect relationship with complexity thus an increase in complexity of the financial statements is likely to lead to a reduction in transparency.  This goes against the IASBs efforts to improve on the levels of transparency displayed by financial statement.  The proposal to create a complex schedule for financial service entities is basically uncalled for considering that sufficient levels of transparency for realised and unrealised fair value gains and losses can be attained through specific presentation in primary financial documents.  Moreover, the proposal in the discussion paper for reconciliation would not be in line with the discussion papers objective of disaggregation.  This is an issue that undermines the objective set forth by the discussion paper.

There are a number of objectives set forth in developing accounting and bookkeeping regulations.  There are cases where the attainment of an objective may undermine the realisation of another objective.  For instance, simple regulation can easily be undone though they allow for usability and transparency.  On the other hand, complex regulations may not be easy to forge though they are associated with low levels of usability and transparency.  This implies that in setting up regulations there is a need to strike a balance between these factors considering that integrity and transparency of financial statements are equally important.  The existence of checks and balances within any amendment is a necessity since perfection is illusive in a practical setting

Investment Decisions, Net Present Value and Bounded Rationality.
The aforesaid article deals with the use of the net present value metric as an important investment appraisal technique in the world while criticizing the fact that the hurdle rate or the discount rate used in real life scenarios by finance managers are based less on theoretical and logical derivation and more on subjectivity and hence reduce the reliability of NPV as an efficient decision making tool as values are usually inflated or deflated. However, the author argues, using theoretical and logical reasoning coupled with relevant figures of behavioral characteristics of managers that it is quite possible that these subjectivities do not act to inflate or deflate NPV, rather are a process of rational decision making as per the internal and external environment confronting business managers and their own understanding of it from time to time.
Hence, the larger argument that the paper focuses on is that of decision making frameworks like the NPV rule only providing one dimension of the problem. Rationality of the business manager in selecting the discount rate is not an impediment to the final outcome of the decision. In effect, a withdrawal from our theoretical derivations or using them along with subjective measures derived from logic may actually increase the quality of the financial management decision making process.
Intangible Benefits Valuation in ERP Projects.
The aforesaid article deals with the use of investment appraisal techniques like NPV and IRR in determining intangible benefits that Enterprise resource planning systems provide to an organization. The cost of maintaining an information system in an organization have become a major component of the overall cost structure and traditional business and accounting tools fail to see the benefits that these information systems provide to the organization. The fact these benefits are not tangible in most cases and have to be shadow priced is another issue. Hence, the article uses relevant examples and theory to stress how companies are today using traditional investment appraisal metrics to value intangible assets and the benefits that they accrue to the firm.
Valuation of Information Technology Investments as Real Options.
The aforementioned article deals with the lack of flexibility that traditional investment appraisal methods such as NPV and IRR represent when undertaking projects of an information technology nature. The problem arises mainly where the one dimensional properties of NPV and IRR do not allow the financial manager to take into account the flexibility of the business manager to abandon, delay or hold onto certain investment opportunities. These kind of opportunities are ever present in the information technology sector where market entry has to be timed in accordance with the availability of suitable ancillaries. For example, Apples Itunes had to be released in tandum with the IPod as both are indispensible and provide a greater competitive advantage. That being said, this does not imply that both were appraised as a single project andor had the same time frames etc.

 Part B Preliminary Evaluation of Proposed Project
The project under consideration by Frank Greystock has many strategic implications. Undertaking the project will allow a massive restructuring and optimization of the firms facilities and lead to operating efficiencies reflected in a higher gross profit. At the same time, the improved reported financial performance together with the effect of a higher future earnings capacity being passed on to shareholders will stem away the downward spiral that the companys share price is in and the threat of a looming takeover.
For this purpose, it is best suited that an NPV and IRR based investment appraisal methodology be used to appraise the financial viability of this project. The decision criterion under the NPV rule is to accept all projects with a positive NPV and in the case of mutually exclusive projects, accept the one with the higher NPV. On the other hand, the decision rule under the IRR mechanism is that where an investment has cash outflows followed by cash inflows, it should be accepted if the IRR exceeds the cost of capital.
The benefit of these types of investment appraisal methods lies in their strong relation to the investor mindset by way of taking the investor mindset into consideration. Specifically, investors are concerned only with cash flows and not distorting accounting income which contains non cash charges when taking investment decisions. This in turn entails that cash flows should be relevant to the decision making process, their timing element should be correctly specified in the financial model and that all incremental cash flows be considered over the full life of the investment including tax savings if any. This is important as a positive net cash flow would imply an addition to the pool of funds available with a firm and hence it is important that any errors or omissions are avoided in order to gauge fully the effect on shareholder values. At the same time, factoring in the timing of cash flows through the use of discounting techniques provides a better tool for analysis as cash flows are directly linked with the opportunity cost to the shareholders of providing funds for the project in the first place.
Hence, as we may see, the NPV and IRR both consider returns from investment with the perspective of investors and provide a fitting appraisal tool. However, the only problem with the IRR technique is its limitation when applied to areas where non conventional cash flow patterns are observed and its reinvestment rate assumption.
The mathematical formulas for both the techniques are given below. Additionally Frank Greystock has also provided us an example of their implementation as per Exhibit 2 of the case and hence a reformulation using the same numbers is not warranted.
NPV 

Where R is the cash flow, the discount rate is denoted by the term I and t stands for time. A summation of all these cash flows for each time period will give us the NPV.
IRR There is no mathematical notation for the IRR and its calculation is done through trail and error mechanisms. We will be using the help of a spreadsheet application to draw out the answer for this.  However, the targeted result of the IRR calculation can be described as below

This is the rate of return (denoted by r) at which the cash flows from a project will return an NPV equal to zero.  Part C Critical Analysis
The concerns raised by different departments with respect to the cash flow that should be used in the capital budgeting exercise are analyzed below and the decision to include  exclude them and to what extent should these be included or excluded have along with theoretical underpinnings in relation to the above are discussed below. However, before we move on to target specific issues, it is necessary to first look at the investor mindset so that we can make an informed decision going forward.
Theoretical reasoning undertakes that investors in a company shares are by virtue of their investment buying a right to an unknown future cash flow. The cash flow is not infinitely unknown, rather, investors in common equity have a moderate idea (say a range of values) of the return to expect from their investments. Hence, while there is uncertainty, there exists an expectation.
Thus, theoretical reasoning suggests that the value of the right to the expected future cash flow is directly proportional to the expected earnings capacity of the firm. The larger the earning capacity, the larger the earnings achieved. The larger the earnings achieved the larger chances of a higher dividend payout, that is, a higher cash flow for the shareholders.
To conclude, management, by virtue of their fiduciary duty to shareholders are required to ensure that they look at investment decisions from the point of shareholders themselves. This is because shareholders are highly receptive of investment decisions as a tool of pricing their investments, taking investment decisions and most importantly, gauging management performance and effectiveness. Thus, the decision to include or exclude a cash flow should ideally come from this common basis of understanding.
Engineering Study
The theory of capital budgeting entails that costs which have already been incurred and are not relevant to the decision making process should be ignored in the analysis. These costs, also called sunk costs, will be paid for regardless of whether the project is carried out or not and hence are not incremental. Hence, the cost of the engineering study should not be taken in the analysis and omitted completely.
Overhead Allocation
As we deal only with incremental cash flows in investment appraisal, overheads that will be incurred regardless of the decision to invest or not should be ignored and only incremental overheads if any should be considered. Here we are not given the information whether these will be incremental overheads or not. We are only asked to adhere to a policy statement of factoring these into the analysis. That being said, although factoring overheads in an investment appraisal exercise needs to be carefully done so as to avoid understatement or overstatement of NPV, they do tend to act as a risk management figure by providing an element of conservatism whenever included.  Hence, we may proceed with factoring these into our analysis.
Cannibalization of Sales at another Company Plant
The theory of capital budgeting has a strong theoretical underpinning to utilize only those cash flows that are incremental in nature and relevant to the decision making process. The cannibalization of sales at another plant within the company suggests that in essence this is not an incremental cash flow and hence not relevant to decision making. This is because, taken together, total company sales will not be affected and only their physical origination will differ.
Use of Excess Transportation Capacity
The use of higher transportation capacity that is already available to the company should not be factored in as a benefit to the company for lowering wastage  non usage of resources. However, as this is an incremental cash flow, the cost of the extra operating expenditure that will be incurred by the cost centre may be included to provide a clearer decision making spectrum. However, these are not specifically available at the moment. At the same time, as the increased throughput will put forward the capital expenditure of the transport division and require investment in specialized equipment related to the English side, these have been factored in accordingly as incremental in nature 
Cash Flow of Unrelated Projects
The cash flow of unrelated projects should not be included in the cash flow analysis of our project. The theoretical underpinning regarding this stems from the fact that different projects have different risk return profiles and those projects that are not financially viable maybe from a strategic business perspective. This lack of conformity with each other leads to the need to separate unrelated projects and consider them separately (Schweser, 2008). Hence, the optimization project currently under consideration should not include the EPC project cash flows as these entail different strategic objectives as well as different risk return profiles. Taking them together may impede the clarity of the investment decision.
Inflation
Capital budgeting and investment appraisal theory entails that inflation be factored in the model so that a clearer decision making spectrum can be created and hence the real value of the investment returns can be gauged. This requires that cash flows and the discount rate should be consistent with each other. At the moment, Greystock has assumed a zero percent inflation environment, that is, all of the figures inputted in his model are at current prices. Since no adjustment has been made (that is the values are all nominal values), the target rate of return or the discount rate should also be a nominal one as investors will demand an inflation adjustment (if cash flows are not adjusted for inflation) as an element of the expected cost of capital .
As we can see, by making the above changes, we will find that our cash flow metrics have become in line with true investor expectations as only incremental cash flows and those relevant to decision making are being considered in the analysis. The reformulations and results of these have been provided in Part D and referenced to Appendix A.  Part D Conclusion
After taking into consideration the above, a revised cash flow analysis table has been prepared and can be found as Appendix One. According to it, the NPV of the project stands at GBP 8.42 Million and the IRR at 24. Please bear in mind that we have not yet taken the effect of a higher operating expense for the transport cost centre. At the same time, as the increased throughput will put forward the capital expenditure of the transport division and require investment in specialized equipment related to the English side, these have been factored in accordingly as incremental in nature. Please note that depreciation on them has been assumed to be straight line with a useful life of 10 Years and no salvage value. Similarly, the overhead allocation has been retained only on account of it acting as a conservative measure. The rest of the concerns have been previously addressed in Part C.
Judging from the above, it seems reasonable to conclude that this project should be accepted as it entails positive NPV and an IRR that is well above the hurdle rate. Undertaking this project will lead to significant cost savings that will improve reported financial performance as well as increase the future earning capacity of the company as reflected by an upswing in share prices on account of higher dividend expectations by shareholders. That being said, it is important to note that this investment appraisal process is a complex one and markets will have to be extremely efficient (from an information receptiveness perspective) and, at the same time, very mature in terms of their receptiveness to complex financial terminology, such as this, for the benefit of a positive NPV to actually pass on to shareholders. If this so happens, shareholders will find the higher NPV reflected in their share prices instantly.

The bar chart prepared in part (c) immediately outlines that the problems of the organisation mainly rest upon its cash flow.  Indeed, a net income of 14,185 is envisaged, which will lead to an enhancement to the financial wealth of the firm.  However, the opening cash balance of 5,000 will diminish to -10,706 during the period under consideration.  The reason behind the different figures stems from the application of the accruals concept in the income statement, which lead to the accrual of unpaid expenditure and the removal of prepaid expenses.  Further more, the prudence concept contends the need of provisions, which are non-cash expenditure like depreciation (Randall 1999).
Solutions that can be adopted to minimise the envisaged cash deficiency may take two main forms.  One encompasses tightening of the credit sales provided, where earlier payments are stimulated by providing a discount.  The other solution encompasses using sources of finance to cater for the capital expenditure of 18,500 envisaged during the year.  The organisation may opt for a short-term loan or acquire the asset through lease agreements in order to diminish the cash outflow that such investment will entail (Pike et al. 1999).

This report will be classified in three main sections.  First financial information pertinent to the present operating income on per one-way flight basis will be provided.  This will be followed by a financial examination of the effect of the decrease in fare selling price as suggested by the market research department.  A relevant costing analysis will also be conducted at the latter section of this paper on the charter offer provided by Travel International.  Such offer will be analyzed both on qualitative and financial aspects.

1. Operating Income per one-way flight
Sales Revenue     (325 x 175)                56,875
Variable Costs
Fuel Costs                        14,000
Food and Beverage Costs (4 x 175)            700
Commission (56,875 x 10)            5,688
Operating Income                    36,487
2. Sales Revenue (280 x 212)            59,360
Variable Costs
Fuel Costs                        14,000
Food and Beverage Costs (4 x 212)            848
Commission (59,360 x 10)            5,936
Operating Income                    38,576
The operating income per one-way flight will increase by 2,089 if the price is reduced as instructed by the market research department.  Such rise indicates that this action is financially feasible for the organization.
3.                                                  
Additional Revenue from Travel (75,000 x 24)            1,800,000
Lost Contribution from lost sales (36,487 x 24)            (875,688)
Incremental Income                            924,312
Financially the charter offer of Travel International is viable, because it will generate an additional income of 924,312 if undertaken.  However, management should also consider qualitative characteristics before proceeding in its acceptance.  For instance, the reduction in the number of flights may negatively affect the image of the company in the market.  Client may switch to other competitors and commence negative word of mouth advertising.  In addition, the reduction in such flights may provide asymmetric information that the company is not operating well and customers may think that it will cease operations soon.  This will further diminish its respective market share.