Most of the time, assets are sold at their fair value, which can be determined by market price, appraisal value, or other valuation method of a given asset. This fair value amount is essentially what the asset is deemed to be worth, given the condition it is in. Considering the fact that all three of these planes were purchased for identical prices and have been used for identical amounts of time, it is more likely that a situation similar to Sale II would occur. In this scenario, all of the planes have the same sales price, despite their carrying values. This results in the opposite outcome compared to the first scenario. For instance, Northwest would now record a gain of $4,655,172, as it has a carrying value lower than this uniform sales price.
However, United would now record a loss of $4,636,364 since its carrying value is above this fair value pricing. Delta’s $750,000 loss does not change, as it faces the same sale price for both scenarios.
variety of expenses, and failing to establish sufficient reserves (liabilities) to pay for income taxes and other expenses. Essentially, this company found several ways to overstate their bottom line and thus artificially inflate their earnings. Endorsed by Arthur Andersen, the accounting firm responsible for auditing this company, Waste Management continued with this fraudulent activity, until they were eventually caught by a new CEO, who questioned the accounting methods used. At this point in time, their stock prices dropped tremendously, leaving their shareholders to face a burden of nearly $6 billion in losses.
As discussed in Part I, depreciation methods can be illegally manipulated for financial reporting purposes. As part of this major scandal, Waste Management used a particularly phony method of depreciating their assets. They avoided depreciation expenses by extending the estimated useful lives of their garbage trucks while, at the same time, making unsupported increases to the trucks' salvages values.
Essentially, this meant that the older and more used the asset was, the more it was worth on the books. By doing this, executives of Waste Management were able to overstate net income and make the company appear more attractive to investors.
These executives committed such blatant fraud for a number of reasons.
First, their compensation was tied to earnings, so they were looking to report the best number possible. Furthermore, they wanted the company to appear profitable so they could retain their high level positions and also reap greater retirement benefits.
Of course, management could not have gotten away with this without the help of their auditors. Arthur Andersen, motivated by under-the-table
compensation, came up with a plan to hide fraud from all years it had taken place and then signed off on the company’s financial reports, verifying their validity.
When they were exposed, they took a couple measures to save their reputation.
These included an agreement to pay a $7 million antifraud injunction and also complying to be censured under the SEC’s rule of practice. However, this obedience was short-lived.
Only a few years later, Arthur Andersen was involved in another scandal.
This time the penalties were much more severe. After aiding Enron with several counts of fraud, Arthur Andersen ultimately had to give up its license to practice as a Certified Public Accounting firm. While the company was not entirely banned from operating, the effects of its fraudulent involvement have kept the firm from recovering even slightly.
7. Recording Liabilities—GAAP vs. IFRS
Executive Summary
Construct is a construction materials manufacturing company that experienced a lot of unwanted EPA involvement and litigation due to their 2007 purchase of a piece of property from BigMix, a concrete manufacturer. This land was expected to have potential environmental hazards; however, Construct believed that holding an escrow account because of this would negatively affect the sales negotiations. Thus, no indemnification provision was reserved.
A year later, BigMix declared bankruptcy, and Construct attempted to gain ownership in part of the failing company. Construct was not successful in this endeavor. However, this seemed to have no effect on their financial statements.
In 2009, the EPA began looking into this tract of land for potential water contamination. Construct was given an estimated probability that penalties would arise from this investigation. However, a liability relating to this could not be recorded due to inadequate probability according to GAAP standards. According to IFRS, the liability would have been recorded, as it was more likely to happen than not.
After more investigation, the EPA determined that there would in fact need to be environmental remediation, and given BigMix’s financial status, the cost
burden of this remediation was placed on Construct. The costs were reasonably estimable and probable, necessary criterion for GAAP and IFRS, so the liability of these costs was recorded on Construct’s books. In 2011, more costs arose and were subsequently added to the existing environmental liability.
Also during 2011, Construct had filed suit against BigMix to help mitigate the losses from this remediation. By 2012, Construct expected that they could recover up to $1 million from BigMix and believed this was very probable. However, according to GAAP and IFRS, no gain contingency could be recorded for this expectation, as it would report revenues before they occurred. Thus, the potential settlement could only be disclosed in the footnotes.
There are several differences between GAAP and IFRS. Some of these differences would have significant effects on a company’s financial reporting, if they were to use one instead of the other. In this case, the only significant difference that Construct would have incurred by using IFRS over GAAP is the expected loss contingency in 2009. However, as actual figures were revealed in 2010, the original difference would have been smoothed out by year-end adjusting entries.