Introduction
It is the belief of this report that extrinsic methods of motivation within companies in the UK can lead toward the development of unethical accountancy practices. One of the current trends in business management within most corporate organizations in the UK is the implementation of extrinsic methods of motivation in order to encourage better performance among employees. Extrinsic motivators take the form of external rewards provided by the company for meeting and exceeding the set metrics that were established (Chaston, Badger, Mangles & Sadler-Smith 2003). Aside from employees, companies themselves also happen to possess extrinsic motivators in the form of financial statements that indicate improved performance on the part of the company which resulted in more profits. The extrinsic motivator in this case comes in the form of greater levels of investor interest in the company resulting in access to more external sources of cash flow as well as the potential to lower interest levels on incurred debt. It is based on this that the upper management of a company often “maneuver” numbers to a certain extent so as to present the company in a good light (Chaston, Badger, Mangles & Sadler-Smith 2003). This comes in the form of a variety of accruals, use of reserves and other such instruments so as to create a more flattering image of the company’s earnings.
Accountants within the UK are well aware of this and there are an assortment of methods that can be implemented to do so in a factual and above all ethical way. Some examples of this come in the form of releasing some of the company’s reserve funds that were set aside for “rainy days” (i.e. work stoppages, natural disasters, etc.) or even by accountants recognizing revenues from products before actual sales are made (a tactic often seen in large retailers within England). It is only when the company enters into a good quarter that a “restructuring charge” is often added in so as to make up for the money that was utilized to increase the company’s earnings in a previous quarter. Various studies explain that among CFOs within the UK, such practices are prevalent among most industries to the extent that nearly 20 to 30 percent of companies within various UK sectors utilize such practices in order to present their financial statements in a better light (Khalifa 2013). As a result, such practices do have an impact on earnings misrepresentation to around 10% of earnings per share that is under the company’s name.
The reason behind such actions which can be considered as “barely” ethical is related to an endemic problem among many of the largest corporations within the UK which is the pressure to meet the quarterly expectations of their earnings in the stock market. However, at times companies take this form of “fact fudging” too far resulting in what can only described as instances of corporate fraud wherein the accountancy department is complicit in providing a means to “cook the books” resulting in the presentation of falsified business data to fool outsiders into thinking that there is nothing wrong or that the company is making more money than it actually is. Instances such as these can be described as form of business failure since it in effect falsifies the performance, cash flow and profitability statements of the company to cast it in a better light (Chaston, Megicks & Williams 2005).
Such actions are unethical due to the potential for investors or banks to invest into a failing company resulting in a significant loss of investments. Examples of this can be seen in cases involving Enron, WorldCom and Adelphia wherein these companies “cooked the books” to such an extent that they listed several billion dollars in assets which in reality were not there (Reynolds 2004). Taking such factors into consideration, this paper will examine the various warning signs that are indicative of business failure wherein unethical accounting practices are being utilized as well as examine why such practices continue to be implemented within the UK despite the proliferation of supposedly ethical workers.
Accelerating Revenues within Financial Statements
One process that has been utilized in various companies in the UK to show higher rates of revenue and a better financial statement is to show a lump sum payment for services that will be implemented over a period of several years as a single payment for that particular year alone. Under the current accountancy laws of the UK, this is actually considered legal since it is still treated as income received however instead of incurring the payments over a period of years, it is considered as a full payment upfront. Companies based in England such as CB Richard Ellis, Savills, Ryland and various other property management firms often utilized this technique when it comes to declaring income accrued from tenants that are renting properties for one year or more yet indicated that their monthly payments are all received within a single quarter (Soderstrom & Sun 2007). Another example of such a loophole in action would be if a company in the UK provided a security service to another company over a period of five years with the contracting company paying for the five year terms of service over a period of several months.
It would normally be the case that the amount for services rendered should appear based on the required monthly payments (i.e. it should be amortized over the service period of the contract). Instead, what occurs is that the services company would record all of the payments as a profit for that year alone despite the costs that would come about by providing the necessary services to the contracting company over the course of several years (Morgan 1990). While it may be true that the payments are contractually guaranteed, the fact remains that the company still has not received them all and will not be able to do so until completion of the entirety of the country. Other methods of implementing an accelerating revenue stream in company accountancy reports within the UK comes in the form of “channel stuffing” which is a method of accountancy wherein a company records all shipments of products to a distributor as sales instead of classifying them as a type of inventory. The problem with this method of accountancy is that it does not take into consideration the amount of time that would be required to make a sale or if all the products could even be sold. There are even instances where products could be returned due to any manner of possible defects (Morgan 1990). Such a strategy is often utilized by Tesco when it comes to its multiple branches as well as by various appliance companies (ex: Sony, Samsung, etc.) despite the fact that there is no guarantee that all of the products will be sold prior to product obsolescence of expiry.
As a result, the information in the financial reports could be grossly misleading with the company incurring losses that are not recorded at all. This is a form of business failure due to the manner in which the actual sales of the company are falsified and any losses are in effect hidden. Losses due to product returns or a lack of sales should appear on a balance sheet since they act as markers to possible problems within the company’s operational status and supply chain. Without these markers in place, it becomes possible to hide internal operational problems which show high levels of sales despite the reality being high levels of returns and low sale outputs.
Delaying Expenses within the Balance Sheet
Another tactic that can be accomplished due to the flexibility of UK accountancy laws is that companies at times implement is to capitalize the cost of making and distributing a particular product. This can be done wherein a marketing campaign (i.e. the distribution of various marketing materials in the form of flyers, CDs, brochures, etc.) is listed as a long term expenditure with the expenses being capitalized in the balance sheet (Mitchell, Puxty, Sikka & Willmott 1994). What should have been the case is that the costs were supposed to appear on the company’s income statement as a loss due to normal operations. By performing actions such as this, companies in the UK are able to show positive income and have apparently low operating costs to outside observers (Mitchell, Puxty, Sikka & Willmott 1994). The reason this should be classified as a form of business failure is due to the fact that by creating a false image this lulls investors into thinking that a company is performing in an efficient and effective manner when in fact it was merely hiding the costs of its operations towards the long term.
Non-recurring expenses being used to hide low performance
The concept of non-recurring expenses are one time charges which are often used in accountancy as a means of analyzing a company’s current operating results. However, the main problem with using this particular accounting instrument is related to the fact that companies are apparently implementing them once per year instead of on an infrequent basis. The end result is that when they want to increase the apparent performance of the company during a particularly slow season they “happen” to find out that they have an excess of funds that have been stored away and place these back into the income sheets of the company (Special section European accounting review on accounting and reporting in family firms 2011).
The inherent problem with such a method is the fact that is clearly being utilized to cover up deficiencies in the company’s operations and is being taken out of context from its original function. Examples of this particular action in progress was noted in various companies in the years after the 2008 financial crisis wherein UK based corporations (i.e. Tesco, Hamley’s, etc.) recorded large increases in operating profits despite the fact that sales within the UK at the time were lagging due to lower than expected customer purchases. This is actually a common tactic when it comes to appeasing investors in the company especially in instances where a strong performance in stock market is being warranted in order for the CEO of the company to gain a bonus due to his/her performance in raising the company’s profitability (Regulation and disclosure of executive compensation European Accounting Review 2012). It is the opinion of this report that despite the legality of such a practice, it encourages companies to portray a false image of their finances which blindsides investors into thinking that all is well within the company when in reality nothing could be farther from the truth (Dumontier & Raffournier 2002).
Off Balance Sheet Structuring
Another of the methods that can be described as “unethical accounting” within the context of UK based companies is the use of off balance sheet structuring. This method of accountancy is actually rather simple wherein a separate legal entity is created by a company through which it can house its incurred liabilities. This helps to create a far “cleaner looking” balance sheet which would make investors believe that the company is a good investment. Under the flexible UK accountancy system, subsidiaries are thought of as separate from the parent company and, as such, the liabilities of a subsidiary need reflect on the parent company itself. This enables the parent company to in effect hide accelerating expenses and massive debt under the guide of a “clean” and well organized balance sheet.
Other Income or Expense Appearing on Company Financial Statements
The concept of “other income or expenses” being utilized is due to the assortment of possible expenses or income lines that a UK based company may incur that would fall outside of the normal categories utilized in most financial statements. It is normally the case that it is in categories such as these that companies attempt to hide prior expenses by netting them against income from other sources. Such sources can come in the form of selling property, equipment or investments that the company had. The problem with this is that it enables the company to boost its earnings artificially through the sale of assets. This creates a false image to investors regarding the company’s earnings and makes them believe that it is positive when in reality it is negative.
Conclusion
All in all, this paper has examined the various manifestations of the UK’s flexible accountancy laws as well as how companies utilize them for their own benefit. This paper has also examined why such practices continue to be implemented within the UK despite the proliferation of supposedly ethical workers. What must be understood is that companies take this form of “fact fudging” too far resulting in what can only described as instances of corporate fraud wherein the accountancy department is complicit. Such actions are unethical due to the potential for investors or banks to invest into a failing company resulting in a significant loss of investments. The source of the problem, which is endemic among many of the largest corporations within the UK, is the pressure to meet the quarterly expectations of their earnings in the stock market. If such expectations were to be removed and companies allowed to operate based on current market conditions, it is likely that the use of these “flexible” accountancy practices would be used a lot less.
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