Where Financial Report Still Falls Short

Indian Institute of Information Technology, Allahabad
Department of Management Studies

Financial Statement Analysis (MFSA720C*)
C3 Evaluation (Review): 4th December 2020
Submitted by: Joel Swapnil Singh (ITM2017002), Vidhi
Agrawal (IMB2020021) and Sudeshna Kirty
(IMB2020018)
1. Introduction countries is difficult, as the profit value of

Cadbury was valued at $690 million as per
Stakeholders would have full confidence in the fi- IFRS and $594 million as per GAAP. The
nancial statements of the company, the decisions fact is many countries formulated guidelines
which they are going to make regarding the com- according to their own convenience.
pany like whether to invest, acquire or not all de- • Revenue Recognition: This problem depicts
pends on the figures present in the financial state- that it is not easy to find out how much pro-
ments. This will help them to estimate the timing, fit is generated from the sale of a product. As
magnitude and uncertainty of the cash flows. This per GAAP, Revenue is not recorded in the
will result in the efficient allocation of capital. books of accounts until and unless it is re-
But the real scenario is totally different, though cognised this may take years. Due to these
the estimations are made in good faith yet that reasons, companies are using unfair means to
doesn’t mean the statements provide the accurate manipulate the value of their company. This
results. With the help of standard metrics compa- kind of practice is easily possible in online
rison between the companies is done but it does space.
not provide the results accurately. Sometimes kno- The new regulation will allow the companies
wingly errors have been interpolated by the ma- to recognise the revenue in the year it is es-
nagers and the executives. timated but at future cost. But that doesn’t
There have been several reforms take place in the mean the problem is eliminated again the ma-
corporate accounting but still, it remains gloomy. nager has to estimate the cost and have the
Companies still continue to manipulate the sta- full chance to manipulate the value just to
tements. Multiple online platforms have come up show the closest value to the financial target.
which drastically change the competitive business • Unofficial Earnings Measures: Businesses are
environment and it also overcomes the shortco- using non-GAAP and non-IFRS measures to
mings of the traditional performance indicators. calculate the financial value from a very long
The new reforms especially the revenue recogni- time. Most commonly used is EBITDA (Ear-
tion, the persistent proliferation of unofficial per- nings before interest, tax, depreciation and
formance measures and challenges of fairly asses- amortization). But the problem is that it is
sing value are impactful. non-comparable from company to company.
There are some tactful practices which manipu- So before making any decision investors and
late the operating decision of the company. It is analysts have to analyse and interpret the
a tough job to find a solution for these kinds of statements properly considering the keynotes
problems. which are attached and at the end of state-
Problems are stated below: ments as adjustment so that the managerial
• Universal Standards: An initiative has been implications and judgements will be clear.
taken with the goal of combining the US • Fair Value Accounting: when the financial cri-
GAAP and IFRS. Many countries follow sis took place in 2008, the US financial ac-
either US Gaap or IFRs. Progress has been counting Board and others financial boards
noticed but getting the true picture of firm decided to adopt fair value accounting but as
and comparison of companies across the a result, it became more confusing, subjec-
1
tive and controversial. In fact, stock valua- tern of speech changes when a person lies.
tion(securities) was also difficult after adop- During their research, they discovered some
ting this method fair values were not accura- verbal cues that connote that there is some
te. Valuation of intangible assets like patent, manipulation in the books of accounts of the
goodwill etc areas are not possible and if the company.
valuation is done as per this method the re-
sults will not be accurate. 3. Conclusion
• Cooking the Decisions Not The books: Inves- The company should disclose the underlying eco-
tors also reflect on the way in which the ex- nomic reality of the business. It is difficult to get
penses are incurred in the accounts of a bu- accurate reports but at least an understanding of
siness. Analysts, accountants, investors. Ma- their vulnerabilities and the availability of new
nagers also purposely overstate costs and tools to detect deception will enable us to achie-
do so to achieve those targets. They also ve that ideal. As businesses are steadily using the
prefer an expense or a loss to be under- timing of operational decisions to artificially im-
provisioned. Over-provisioning and under- prove output figures, diligence is more difficult to
provisioning practices have been rendered identify and control.
less objectionable by recent amendments to
GAAP and IFRS laws. Some suspect that re-
cent reforms in legislation have undermined
the ability of corporations to manipulate dif-
ferent financial reports. Managers are now at-
tempting to change statistics by manipula-
ting operations instead of reports.
2. New Analytical Tools Can Help

Investors and the board members were very much
evident with the current scenario; that manipula-
ting operational decisions to report higher profits
in the short term will undermine the long-term
competitiveness of the company. Now, it is also
clear that accounting regulation is also helpful to
remove unfair accounting practices. Now investors
and board members will ask for more information
regarding the operation decisions rather than of
accounting reports. New techniques adopted by
the analyst and investors are:
• Benford’s Law: Benford’s Rule on the fre-
quency distribution of leading digits in nume-
rical data sets is one approach to the study
of company reports that has recently gained
favour in financial markets. The rule has been
in effect for a long time, but it has only been
implemented recently in the accounting and
financial sector: insurance companies have be-
gun to use it to detect false claims, the IRS to
detect tax evasion, and the Big 4 accounting
firms to detect false claims.
• Verbal Cues: Another tool to detect fraud
and false practices is Verbal Cues. Resear-
chers find out that psychological studies pat-

Where Financial Report Still Falls Short

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Indian Institute of Information Technology, Allahabad

Department of Management Studies

1. Introduction countries is difficult, as the profit value of

2. New Analytical Tools Can Help

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