EARNINGS MANAGEMENT CASE

It is recommended that Grace, Inc. adopt the conservative approach to its warranty expense for 2001 and 2002 in order to reflect accurately the company's financial position.

Warranty expense is a subjective matter open to several interpretations, and an aggressive approach has been proposed which would help the company show an increase in income during the 2001 to 2002 period (see attachment). The total warranty expense for these two years would be the same amount ($10,000) regardless of whether the conservative or aggressive approach is used. However, the aggressive approach would be a deviation in the company's own procedures that have been in place in recent years and does not address the underlying problem, which is that revenues are expected to stay flat from 2001 to 2002. Because of this, it could be construed that the management of Grace was intentionally trying to mislead investors and other stakeholders into believing that the company's performance was better than a more conservative--and the company's own traditional--approach would indicate. The Securities and Exchange Commission has been particularly watchful of discretionary items such as warranty expense and other "cookie jar" reserves since the Enron and WorldCom scandals of the early 2000s, and is particularly suspicious when a company deviates from its own reporting practices.

EXPECTATIONS AND FORECASTS AT GRACE, INC.

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ect themselves and their clients from fraud investigations, and to ensure that financial statements reflect the company's operations (Ramos, 2003). ANALYSIS The aggressive technique being considered here would result in the largest nominal increase in income over the five-year period, making this a material issue. At the same time, the aggressive approach is difficult to defend from a business standpoint since the company's own forecasts indicate a lower warranty expense and these forecasts are historically accurate. Since the primary reason for using the aggressive approach is to change the impact of the financial statements without a justifiable business foundation for doing so, this course of action is to be discouraged. REFERENCES Financial statement fraud, integrity of financial information continue to be front burner issues. (2003, February). CPA Letter, n.p. Retrieved from the Internet 25 Sep 2003: http://www.aicpa.org/pubs/cpaltr/feb2003/financial.htm. Ramos, M. (2003, January). Auditors' responsibility for fraud detection. Journal of Accountancy, n.p. Retrieved from the Internet 25 Sep 2003: http://www.aicpa.org/pubs/jofa/ jan2003/ramos.htm. HOPE FOR THE TERMINALLY ILL CASE BACKGROUND Livi

Category: Economics - E