Deck 12: WorldCom: The Definition of an Asset

Question 1

Consider the principles, assumptions and constraints of Generally Accepted Accounting Principles (GAAP). Define the revenue recognition principle and explain why it is important to users of financial statements.

Answer 1

Accounting:
In simple words, accounting is defined as a process to record, classifying, and analyzing the financial information of an organization. For accounting requires a specific knowledge because it is not a single process as it includes many sub-processes under it.
For this process a firm uses the method of accounting that are:
1. Cash accounting
2. Accrual accounting
3. Combined method
Accrual accounting:
Accrual accounting is a type of accounting in which transactions are recorded when they are recognized by the company.
Cash basis accounting:
Cash basis accounting is a type of accounting in which the transactions are recorded when cash is paid or received by the company. 
Accounting principle:
Accounting principle is a rule and guideline followed by the company to report their financial data.
Accounting principle includes:
1. Expense reorganization principle
2. Revenue reorganization principle
3. Matching principle
Revenue:
Revenue is the total income earned by the business before the deduction of expense in its normal course of activity by performing the service or selling goods.
Example: Amount received from the sale of goods and services, rent received, commission.
GAAP:
GAAP is a generally accepted accounting principle. It is the set of accounting principles and standards. It was issued in 1973 for US public and private companies by the financial accounting standard board for issuing a public statement. It is the set of accounting guidelines lines and rules used by the companies for financial reporting.
Revenue reorganization principle is a generally accepted accounting principle that sets out when and how revenue is recognized. Under the accrual, method revenue is recognized when it is earned. In cash accounting revenue recognized when cash received. As per the standard, ASC 606 revenue reorganization standard provides a framework to recognize the revenue by contracting with customers.
As per ASC 606 revenue is recognized when these five following steps are fulfilled:
1. Identify the contract and agreement with the customer.
2. Identify the performance obligation must be handled
3. Recognized the transaction price
4. Allocation of the transaction price
5. Recognize the revenue when performance obligation satisfies by the entity.
There are two types of users of accounting information:
1. Internal users ( Owners, management, employee and workers)
2. External users (Banks and the financial institution, investors, and creditors)
Recording revenue at the wrong time misstates the financial statement and provides an inaccurate financial position of the organization. If companies' revenues are recorded by the companies too early that overstated the profit than the actual profit. The users of the financial statement get accurate information about the net profit of the organization when the revenue recognized principle is used by the organization. In it, a company cannot record revenue when it feels.

Question 2

Describe specifically why the revenue recognition practices of Dex were not appropriate under GAAP.

Answer 2

GAAP:
GAAP is a generally accepted accounting principle. It was issued in 1973 for US public and private companies by the financial accounting standard board for issuing a public statement. It is the set of accounting guidelines lines and rules used by the companies for financial reporting.
Accounting principle:
Accounting principle is a rule and guideline followed by the company to report their financial data.
Accounting principle includes:
1. Expense reorganization principle
2. Revenue reorganization principle
3. Matching principle
Revenue reorganization principle:
Revenue reorganization principle is a generally accepted accounting principle that sets out when and how revenue is recognized. Under the accrual, method revenue is recognized when it is earned. In cash accounting revenue recognized when cash received. As per the standard, ASC 606 revenue reorganization standard provides a framework to recognize the revenue by contracting with customers.
Revenue is the total income earned by the business before the deduction of expense in its normal course of activity by performing the service or selling goods. Example: Amount received from the sale of goods and services, rent received, commission.
As per ASC 606 revenue is recognized when these five following steps are fulfilled:
1. Identify the contract and agreement with the customer.
2. Identify the performance obligation must be handled
3. Recognized the transaction price
4. Allocation of the transaction price
5. Recognize the revenue when performance obligation satisfies by the entity.
GAAP is the set of accounting principles and standards. As per revenue recognition, principal revenue is recorded when two conditions are met such as (realized, realizable, and earned). Revenue recognition is the first step to help in determining the profit for the period.
D change the accounting method in the mid of the year and he took the wrong decision. He recognized revenue early in December 2000 in place of the year 2001. Revenue should be recognized at the time of distribution. There should be a control advertisement in the printed directory and transferred to it when it is printed and distributed. In the case revenue recognized early the part of the contract and when some directories are distributed with the deferred amount. Q's executive made misleading revenue statements from its directory service units. He manipulates revenue D for 2000 and 2001 by altering publishing dates of directories.

Question 3

Consult Paragraph.06-.07 of AU Section 319. Do you believe that Qwest had established an effective system of internal control over financial reporting related to the revenue recorded by Dex in its financial statements? Why or why not?

Answer 3

Internal Financial Controls include:
1. Operational Controls.
2. Fraud Prevention Controls.
3. Internal Controls over Financial Reporting
Internal Controls over Financial Reporting are the controls that ensure that, transactions recorded in the books of accounts, shall be -
1. Authorized by the appropriate level of management for example - Some transactions would require authorization from the management, whereas some transactions would require approval from the Director/CEO
2. Recorded accurately in monetary terms.
3. Processed properly in accordance with the standard operating procedures of the organization
Essentially, they are controls relating to books of accounts and financial reporting. They include within their wide scope, safeguarding of assets, and authorization of transactions, maintenance of records and preparation of financial statements.
Qwest has not established an effective system of internal control over financial reporting, the revenue recognized in the year 2000 has shown a considerable increase in the revenue and earnings, and it does not show a true view of the state of affairs of the company. This circumstance amounts to recording of fictitious journal entry by the management and hence leads to fraudulent financial reporting.
The accounting system followed by the D is not in compliance with GAAP.
The auditor should ensure the following:
1. Whether the transactions are properly valued.
2. Verification of the valuation of assets at reasonable intervals.
3. Monitoring of accounting/financial controls.
4. Valuation of assets by experts.
5. Proper documentation and reasons for the arrived valuation of assets.
6. Accountability and safeguards of assets.
7. Independent checks on the valuation of assets.

Question 4

Consult Paragraph 25 of PCAOB Auditing Standard No. 5 and/or AU Section 319.34. Next consider the impact of the pressure exerted by Qwest's senior management team to meet aggressive revenue and earnings targets. Comment about why such a "tone at the top" would have a pervasive effect on the reliability of financial reporting at a company like Qwest.

Question 5

Consider the role of an upper manager at Dex. Do you believe that a "point of publication" method of accounting is allowable under Generally Accepted Accounting Principles? If so, make an argument that supports the recognition of revenue related to the Colorado Springs directory in December 2000, as opposed to 2001. Do you believe that the actions of the upper managers at Dex were ethical? Why or why not?