Analisys for Conservative Recognition or Cookie Jar Reserves

Summary:

O’Brian Software is a family software firm started by Amelia O’Brian. She started the company on a very small scale many years ago, but it has grown tremendously over time. The company went public and she now holds the position of chief executive officer at the company, while managing the majority of the business operations herself. Nick, who is Amelia’s nephew and a recent graduate with an accounting degree, began working for Amelia’s company. Nick was inducted as an auditor at junior level for the company and has been working only for a few months now. Amelia O’Brian has been facing issues because she does not have a sufficient understanding of the accounting procedures used in her company and her involvement with the company’s accounting function is very limited.

Overall, the company has exhibited qualities of honesty and integrity in all of its functions. Though the company is owned and managed by the O’Brian family, all the important decisions are finalized only by proper discussion and final approval of the board of directors audit committee. All financial activities and transactions in the company are run by its CFO, Lee Marchetti. He is recognized as a trustworthy executive who ensures tight internal checks and controls on company’s finances.

Current situation:

In the process of reviewing the company’s financial statements, Nick recognized some issues with software revenue recognition. He had a feeling that there was a possibility that the company was creating “cookie jar” reserves, which were aimed to inflate its earnings for times that were not so good. This situation was even more problematic because the company was planning to launch its new software in a short while. Nick was responsible for the auditing function and he addressed his concerns to Lee Marchetti. Lee sounded very reassuring about the company’s accounting practices in his discussion with Nick, and said that Nick’s concern is not a threat, more so because the revenue...