CONSERVATIVE RECOGNITION OR COOKIE JAR RESERVES
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 ...view middle of the document...
Lee also told Nick the company’s financial statements and its deferrals and estimates are documented in accordance with the SEC rules.
After conversation with Lee Marchetti, Nick decided to speak to his aunt Amelia about his issues. Amelia pointed out that she wasn’t very sure what Nick was actually referring to, so he tried to clarify what he foresaw as potential problem for the company. Upon hearing Nick, Amelia admitted that the problem could turn out to be very serious and asked Nick whether or not they should present the issue to the audit committee.
There are various issues which can significantly damage O’Brian Software Company. The main issue that comes up is that investors might perceive the company’s revenue recognition policy as a scheme to put aside revenue for a later stage when there is a slump in business activities. This issue is also known as the “cookie jar reserves” and is a prohibited activity. It is considered to be a negative point on the company as it could mislead investors about the true financial health of the company. It has been stated in FASB Statement of Concepts that “bias in estimating components of earning, whether overly conservative or not conservative, usually influences the timing of earning or losses rather than their aggregate amount. As a result, unjustified excesses in either direction may mislead one group of investors to the possible benefit or detriment of others (FASB, 2008)”.
As Robert O’Connor, President and CEO of Softrax Co, points out that smoothing revenue are illegal and unethical. Obviously, Nick is aware of the problem but he does not know enough to determine the existence of the problem in order to come up with a more informed decision. In his meeting, Lee had stated, “I can assure you the accounting practices here at O’Brian will never cast doubt on the integrity for this company’s financial statements. Our deferrals and estimates are well documented, and in accordance with SEC rules (Carpenter, 2003)” Lee is known to be an honest man, and if he is right then bringing up this issue will cause unnecessary stir for investors. Furthermore, restating earnings can lead to shying away of investors to continue doing business with the company. Nick needs to do more research and if he turns out to be right then no investigation will prove detrimental for the company at some point in the future.
Another question that is raised in this case is the appropriateness of Amelia O’Brian being a proper candidate to run this company. According to the Section 302 of the Sarbanes-Oxley Act, “CEO and CFO of an organization certify and assert to stakeholders that SEC disclosures, including the financial statements of the company and all supplemental disclosures, are truthful and reliable, and that management has taken appropriate steps to satisfy themselves that the disclosure processes and controls in the company they oversee are capable of consistently producing financial information...