1. Analyze the Issues Attributed to Financial Distortion/Misstatement

1. Analyze the ISSUES attributed to financial distortion/misstatement

Financial (Accounting) distortion/misstatement

Financial distortions are deviations of reported information in financial statements from the underlying business reality. These distortions arise from the nature of accrual accounting; this includes its standards, errors in estimation, the trade-off between relevance and reliability, and the latitude in application.

Issues attributed to financial distortion and misstatement:

Accounting Standard

Accounting standards may contain some responsible for distortions. At least three sources of this distortion are identifiable. First, accounting standards are the output of a political process. Different user groups lobby to protect their own interests. In this activity, standards sometimes fail to require the most relevant information. The example is accounting for employee stock options. Moreover, the second source of misstatement from accounting standards arises from certain accounting principles. For example, the historical cost principle can reduce the relevance of the balance sheet / Statement of financial position by not reflecting the current market values of assets and liabilities. Furthermore, the transaction basis of accounting results in inconsistent goodwill accounting wherein purchased goodwill is recorded as an asset but internally developed goodwill is not. In addition, double entry implies that the balance sheet articulates with the income statement---meaning that many transactions affect both statements. However, an accounting rule that improves one statement often does so to the detriment of the other. For example, first in fist out (FIFO) inventory rules make sure the inventory account in the balance sheet reflects current costs of unsold inventory. Yet, last in first out (LIFO) inventory rules better reflect current costs of sales in the income statement. Third source of distortion is conservatism. For example, accountants...