Chapter 5 Study Notes - Ensuring Integrity of Financial Information

Chapter 5 Study Notes - Ensuring Integrity of Financial Information

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1 Chapter 5 Ensuring the Integrity of Financial Information Outsiders, the investing community, banks and other members of the financial community, rely on the financial statements of a corporation as the representation of the “worthiness” of a corporation regarding investment or as a credit or business risk. Assurance is needed that these financial statements appropriately represent the financial position of the corporation. This chapter discusses the procedures and policies companies should employ internally and the role of the external auditor (CPA firm) in safeguarding the integrity of the financial statements and protecting the assets of the corporation. Types Of Problems That Can Appear In Financial Statements 1. Errors involve unintentional mistakes that can enter the accounting system at the transaction and journal entry stage or when journal entries are posted to accounts. 2. Disagreements in judgment occur because of the differing incentives of those associated with the financial statements. While management may have an incentive to present an optimistic view of the company’s performance (e.g. bonuses, stock options), external auditors have an incentive to ensure full disclosure of all relevant issues (protect professional reputation, protect against lawsuits from dissatisfied investors or creditors). These differing incentives typically result in financial statements that fairly reflect the financial performance of the company. Some recent accounting “scandals” (e.g. Enron) have brought charges that the external auditors (e.g. Arthur Andersen LLP) were providing such profitable outside or consulting services to the client that they were no longer sufficiently independent when it came to the audit of the financial statements. 3. Fraudulent financial reporting involves intentional misrepresentations in the financial statements. Safeguards are built into the accounting and reporting system to minimize the possibility that these problems will be reflected in the financial statements. Internal Controls
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Chapter 5 Study Notes - Ensuring Integrity of Financial Information

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