Question

Chapter 11: What creates a conflict of interest? Give an example. Chapter 12: What is a "big bath? Give an example using a liability account and an expense account tell and how it would create overstatement and/or understatement the balance sheet and income statement? hapter 13: What does it mean to capitalize an expense? Give an example of this practice and explain the overstatement and understatement effect on the specific accounts used in your example on the balance sheet and the income statement Chapter 14: Give an example of an unreasonable expectation and explain how it might cause an employee to commit fraud or abuse

Answer 1

1. Conflict of interest is where there Interests of one person/organization opposite/conflicting with interest of another. The intention of both parties are not in the best interest of both.

eg. An organization by name ABC Ltd. has one of its primary aims to expand Profits of the company. On the other hand it gives incentives to its employees based on the number of contracts they sign. While the company expects its employees to enter into good profit deals, an employee for his own personal gain to increase the number of contracts he successfully gets for the company, may give discounts to the customer so he can successfully win the contract. The interest of the employee is to maximise his incentive basis the high number of contracts he wins for the company. This represents a conflict of interest of the employee and the company.

Another example, an employee, on behalf of the company, sign's up with a service provider, who is also a relative, not on the basis of quality of services/price competiveness , but purely on basis of the relation.

2. Big Bath is a method of management by which , the company makes its accounts apprear worse than they actually are, so that the company can report better profits in the up coming years.It is a technique of manipulating the accounts to show increased loss in the current year so that the future periods can show better profits. This technique is often discouraged by the auditors.

eg: Chaging/manipulating the method calculating provision of Bad debts or creating a specific reserve against a risky customer, to increase the expense hit for a particular year.

Entry - Bad Debts Provision (Expense) A/c Dr.

           To Bad Debts Reserve (Liability) A/c.

Bu doing this, the expense hit for the current year is increased, and therefore profit is reduced. Also to this extent an increased liability is created. In the next year, the provision can be reduced so as to increase the profits in such future period.

3. An expense incurred by a company, from which it will get benefit for more than one accounting year is considered as an asset.

Eg: Commission paid by a company to a seller for winning a contract with a customer over the period of the contract. If the conteact with a client is for a period of 5 years, then the commssion for that contract paid to the seller may be amortized over a period of 5 years. In such a case, the expense is understated and the profits are increased.