Zar, Inc.: a Case in Earnings Quality

Module 1

1. Conservative accounting always chooses the option that results in lower income or assets and has the strictest revenue-recognition criteria. It also recognizes all expenses as they are incurred and all losses as they are discovered (Accounting Conservatism Definition, n.d.). Whether it is “overly conservative” or not is subjective to the regulator. It can be ‘too conservative’ in the sense that potential losses would be recorded on the financial statements or disclosed in the notes from lawsuits although the contingency is not as likely or by understating its assets, which automatically makes the company look ‘poorer’ than it actually is, affecting investor and creditor decisions. During the financial crisis, when bankers were giving out mortgages and securities to borrowers with unstable credit history. Accountants were blamed for their substantial losses and regulators were forced to suspend the accounting policy of recording the assets at fair value. Eventually, “auditors and others thought they had to use fire-sale prices” for mortgage-backed securities. “While auditors may have been too conservative, some financial institutions were in denial as the credit crisis unfolded” (O’Hara, 2010).

2. Brown’s ideas are correct because consumers are currently cutting on costs and not buying software due to the temporary decline in the economy. The company has almost finalized the software development and only needs to code it. To delay completing the prototype, will not make them lose profit even more. They can still release the product in 2012 as planned, plus the economy will most likely recover by then and sales will eventually rise. Zar should have other priorities like improving accounting policies to undertake the firm’s performance.

3. Brown’s objectives for writing down certain inventories are lowering tax liabilities, saving taxes, while removing ‘excess’ inventory, which is not generating sales either way. This is achieved by increasing expenses...