Introduction

In accounting, the production, processing and transmission of critical information regarding the performance of a business entity is essential. This is because the financial information of a business entity is crucial to several interested parties of the business. These interested parties include the entrepreneurs, business financiers, shareholders among others. The transmission of this financial information must be through systematic financial statements to the interested parties. The information transmission will either be through book keeping, accounting and auditing(Zack, 2009).

The accounting community has struggled over the years to harmonize the accounting process. As a result, several rules and regulations have been put in place to ensure that both users and providers of accounting information can easily communicate. These rules and regulations are contained in the Generally Accepted Accounting Principles (GAAP) and also in International Financial Reporting Standards (IFRS).

Introduction and adoption of IFRS in major listed companies was to make the communication easy among the different users of financial information. The standards have been adopted in several parts of the world such as European Union, Australia, Hong Kong, India, South Africa, and Singapore among other states. The IFRS is understood as advancement of the traditional International Accounting Standards (IAS). The standards outline how different financial elements should be treated in financial reporting. The international financial reporting standards are guided by three underlying assumptions which includes; going on concern, stable measuring unit and presence of units of constant purchasing power. The idea to introduce the concept was as a result of increasing international trade which necessitated introduction of a common accounting language.

The need for common accounting language also leads to introduction of Generally Accepted Accounting Principles (GAAP). These are globally accepted rules, conventions, procedures, and standards for financial reporting as outlined by financial accounting standards board (FASB). Though, the set standards are acceptable in accounting, they are sometimes discredited since they differ in different countries thus making it difficult to compare. This has resulted to several firms using IFRS in their reporting practices to ensure comparability of financial information.

Discussion

Accounting frauds have been of major concern in the accounting world. Majority of these accounting frauds have been achieved through malicious misrepresentation of financial statements by managers to fulfill their selfish interests at the expense of the stake holders. Both IFRS and GAAP have provided numerous avenues for accounting malpractices which have led to massive losses by major corporate bodies. There are several cases of accounting frauds such as World Com, Freddie Mac Scandal, HealthSouth Scandal,Tyco scandal and Enron scandals have been some of notable accounting frauds global.

The managers in an organization may decide to give false information to the users of financial information with an objective of fulfilling their own interests.  Most of accounting frauds are as a result of either overstatement or understatement of financial elements in the financial statements. For instance, managers may decide to inflate the firms’ expenditures with an objective of squandering the difference between the actual and inflated figure. Other elements such as the depreciation time for some of the company’s assets can also be falsely increased in the balance sheet for greedy and selfish interest of the managers(Zack, 2009).

Another common practice through which a firm can be defrauded of its resources is through misrepresentation of crucial information on the balance sheet. For instance, in the infamous Enron scandal where huge debts incurred by the company were kept off the balance sheet. This resulted in the shareholders suffering huge losses amounting to $74 billion and several employees becoming jobless. The motive of misrepresenting such crucial information is creating a rosy picture of the company. This gives the stakeholders of the organization false information of the company’s financial soundness. Such information is critical in making vital investment decisions by the stakeholders. This is because few or no investors who could be willing to invest in a company which cannot service its debts as they fall due.

Both IFRS and GAAP have different provisions on the disclosure of certain essential financial information. The differences in disclosure have been used to the advantage of selfish managers who want to defraud corporations huge amount of money. Example of misused elements in the financial reporting is the treatment of contingencies. The contingencies could either be in terms of assets or liabilities. Both IFRS and GAAP have clear guidelines on how these should be identified, measured and recorded. Corporations with huge contingent liabilities are likely to be faced with risk of suffering from colossal cash losses as opposed to those with less contingent liabilities. This could translate to increased risk to investors(Kranacher, Riley, & Wells, 2011).

Under GAAP, the businesses are required to classify contingent liabilities as probable, reasonably possible or remote.  This should be done as stipulated by the financial accounting standards board (FASB). Under these procedures, it is required that only the most probable contingent liability should be recognized on financial statements. The reasonably possible contingencies should be set aside until their outcome is realized.It should be noted that contingent liabilities are just accruals since they are not immediately realized as recommended by FASB (Jackson & Jenkins, 2009).

According to GAAP and as outlined by the FASB, contingent liabilities should be treated as future costs which should be a credit entry in the liability account. After the liability is incurred the actual expense should be a credit entry in the cash account which should be accompanied with a debit entry to the liability account to complete the double entry. It should also be essential to note that some contingent liabilities should be excluded since they should not be recognized as liabilities. Example of unrecognized liability includes retirement pensions since time and amount are certain and they are not treated on fair value estimates(Jones, 2010).

The disclosure of contingent liabilities under GAAP is strictly outlined by FASB.  It is required that probable contingent liabilities be reported directly on the on financial statements. However, it should also be noted that GAAP also provides that the contingent liabilities should be recorded as unspecified expenses charges(Kranacher, Riley, & Wells, 2011). It is also a provision of GAAP that those contingent liabilities that pose more losses than it would be estimated must be clearly disclosed. It is also clearly stipulated under the FASB statement number 5 that obscure or potentially misleading contingent liabilities should be disclosed. This should be in addition to the ones incurred after creation of financial statements but before they are released. However, some greedy managers and accountants can be tempted to take advantage of the loopholes in this accounting process to manipulate financial statements for their selfish interests.

The measurement of the contingent liabilities under GAAP is also outlined by the FASB. It is required that contingent liabilities should be reasonably estimated for effective and sensible recording of financial statements. This is because failure to fairly value the contingencies can have serious repercussions to the financial soundness of the firm. For example if Apple Inc. has $ 50 billion sales and determines its contingent warranty liability to be 1% instead of 2%, then there will be  an increase in the company’s revenues which subsequently leads to increase in working capital. The underestimation or overestimation of contingent liabilities can be used to fraudulent gains by selfish managers and accountants.

The treatment of contingent liabilities and assets under International Financial Reporting Standards (IFRS) is contained in the International Accounting Standards no 37 (IAS 37). This is an accounting procedure outlined by the International Accounting Standard Board (IASB). It is here whereby provisions for contingent liabilities in terms of recognition, measurement, exceptions and disclosure in accounting are outlined. The provisions were outlined in 1998 and provide essential principles regarding the treatment of contingent liabilities(Jackson & Jenkins, 2009).

According to IAS 37 and the IFRS, it contingent liability is defined as the liability of uncertainty in terms of timing and amount. The IAS 37 also requires certain provisions to be fulfilled for them to be recognized as contingent liability. Some of these provisions are; the liability is as a result of pat occurrence, the payments are probable i.e. there is likelihood of an expense and lastly the amount to be incurred can be reliably estimated. The amount estimated should be the best required to settle the obligation during the financial reporting date.

It should be noted that under IFRS, contingent liabilities are not recognized. Nevertheless they should be disclosed unless the possibility of an expense is not probable. The probability of the contingency must be beyond doubt. These contingent liabilities could be insurance premiums, retirement pensions just to mention a few. It is also outlined that the contingency is brought about by a past occurrence which will be confirmed in future events whose occurrence is entirely out of the entity’s control. It is required that contingent liabilities must be disclosed as long as chances of causing outflows of entity’s resources are significant. This provision may be misused by selfish managers to deprive stakeholders essential information on the financial soundness of the company. The IFRS requires that sufficient information is disclosed in the notes to financial statements for the users to understand the nature, timing and amount associated with these contingencies (Jackson & Jenkins, 2009).

There are major differences in the treatment of contingent liabilities between the IFRS setting and the GAAP. For instance, short term debt refinanced before statement issuance is often shown as noncurrent under the GAAP. However, under the IFRS can be depicted as noncurrent in disclosure but this can either be before or after issuance of financial statement. This can be a major avenue for manipulation of financial position under IFRS. This is because there can be further representation and disclosure even after financial reporting is done(Epstein &Nach, 2009).

Under the GAAP accounting rules, there are different and specific rules that govern certain provisions. For instance, environmental liabilities have specific rules which are different from insurance liabilities. On the other hand, IFRS has general guidance for all provisions. The general rules to all provisions under the IFRS make manipulation more eminent as opposed to GAAP. This is because managers can include items which are not liability in the financial statements. There is also a high likelihood that overstatement and understating for greedy reasons may not be properly detected. Another major difference between the IFRS and GAAP lies on recognition of contingent gains. Under GAAP, contingent gains are not recognized which is opposite of the IFRS provisions.

However it is also important to note that there are several major similarities between these two accounting procedures. The two accounting principles treat only the most probable contingencies. These contingent liabilities must have an effect on the economic status of the organization. Under IAS 37, it is clearly stated that there must be an outflow of resources in the organization for the contingent to be included in financial reporting (Bologna & Lindquist, 1995). Nevertheless it is essential to note that the threshold of probability under the GAAP is stronger than under the IFRS. This provides another avenue for the managers to manipulate the financial statements. What could be a contingent liability under the IFRS may not meet the threshold under the GAAP.

Conclusion

Generally accepted accounting principles have been an important tool in accounting. For a long period, many firms have relied heavily on the conventions and jurisdictions provided by the accounting principles. However, it should be noted that financial information reported through GAAP is not gospel truth. Majority of managers in different organizations have the tendency of using GAAP in deceiving and defrauding stakeholders. This is actually achieved through technical compliant methods with GAAP but display economic illusion to stakeholders. Some of these fraudulent practices are carried out to ensure job security by the managers, get extra income apart from the agreed remuneration as well as to deceive more investors to invest in the said companies(Bologna& Lindquist, 1995).

However, manipulation of financial statements should be condemned with the strongest possible terms. The accounting community should work in conjunction with the respective authorities to minimize accounting frauds. There are also spirited efforts to consolidate the IFRS and GAAP accounting principles. This would be a great step in achieving a common accounting route that would help fulfill transparent, credible and comparable accounting process. The managers and accountants should be extensively vetted to ascertain their ethical standards. Proper training of the company’s personnel is also vital in ensuring that transparency is ensured in the accounting process.

References

Bologna, J., & Lindquist, R. J. (1995). Fraud auditing and forensic accounting: new tools and techniques (2nd ed.). New York: Wiley.

Epstein, B. J., &Nach, R. (2009). Wiley GAAP 2010: interpretation and application of generally accepted accounting principles. Hoboken, N.J.: Wiley;.

Jackson, S., Sawyers, R., & Jenkins, G. J. (2009). Managerial accounting: a focus on ethical decision making (5th ed.). Mason, OH: South-Western.

Jones, M. (2010). Creative accounting, fraud and international accounting scandals. Chichester: John Wiley & Sons.

Kranacher, M., Riley, R., & Wells, J. T. (2011). Forensic accounting and fraud examination. Hoboken, N.J.: John Wiley.

Zack, G. M. (2009). Fair value accounting fraud new global risks and detection techniques. Hoboken, N.J.: John Wiley & Sons.

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