>> Financial Accounting
Some companies wish to report a steady growth in income to investors and achieve this goal through accounting practices known as earnings management. One type of earnings management is through the use of reserves for maintenance (also known as cookie jar reserves).
For example, in good years a company may increase maintenance expense by ten or twenty percent over their actual cost for the year. The company will record this by a debit to maintenance expense and a credit to a liability account created for this purpose, called deferred maintenance. In a bad year, the company will debit the deferred maintenance account and credit maintenance expense.
The rationale is that when times are good and the factory is busy, the company may get behind on maintenance. When a slowdown in production occurs, the company has time to catch up on its maintenance.
The actual practice has been observed to have much more to do with the company's ability to report a steady growth in earnings than with the rationale given above.
Using the information provided in the Context for the assessment, along with other sources of information, write a 3-5-page analysis that addresses the following questions:
Do you think that the practice of earnings management through the use of deferred maintenance is ethical? Defend your answer.
Is the practice of earnings management through the use of deferred maintenance allowed in the United States? How does US GAAP differ in this treatment from International GAAP? Support your answers by the use of at least one reference.
3-5 pages, including references and title page
Times New Roman, 12 point
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There are peak seasons and also there are down seasons. In the peak seasons the entities cannot cover up with the required maintenance activities. Against this in the down seasons when there is appropriate availability of time and space, the entities carry on with maintenance works. But that is a practical situation, and if it be carried out the same way in accounts, a high level distortion may occur. The result of which would be that while the maintenance expenditure debited to the income statement in one period would be extremely high against the other period in which it would be low. Therefore the entities increase their maintenance expenses in good years and use the additional maintenance expenses in the bad years. This is called deferred maintenance or cookie jar reserves. The report highlights the issue, studies it on ethicality and compares the perception of GAAP in US upon deferred maintenance against International GAAP.
Madsen (2006) recognizes deferred maintenance as the "maintenance, system upgrades, or repairs that are deferred to a future budget cycle". In the past years, cause of this deferment used to be the non-availability of funds in bad years, but now the reason has changed to the non-availability of time and resources to carry out maintenance in good years.
Ethicality of Deferred Maintenance
While it is provided that not making deferred maintenance provisions can distort figures of the profit of the organization, making deferred maintenance provisions cause lack of transparency. Lev and Zarowin (1999) pronounce several boundaries for financials, of which one is the period which it is expected to cover. The financial statements are generally presented over one financial year. And therefore as per the matching concept, only incomes and expenditure related to that specific financial year gets place in the income statement.