Lesson 1 notes

Have you ever thought that you might want to

start and run your own business?

ACCOUNTING

Your Own Boss

The Language of Business

Take an Idea and Run

Big Money

American Dream

1.

2.

What would a person need to start a

successful business?

A business is an organization which seeks

to provide goods or services to customers.
Three Basic Kinds of Business
1. Manufacturing
2. Merchandising
Retail
Wholesale
3. Service

1.

Idea- A good idea for a product or service that

can be sold at a profit.

2.

Capital- Money or resources to bring that

product or service to life.

3.

Management Skill- The ability to effectively

employ those resources and produce a profit.

Some businesses provide a combination of these

goods or services to customers

Some businesses may be operated on a non-profit basis but they

still provide goods or services and require capital and
management skills to operate effectively.

Restaurant:
Prepare Meals
Deliver Directly to Customers
Provide Services

3.

4.

Characteristics of Debt Financing

"It takes money to make money"

Besides using your own money or resources, there are only two
ways to access capital.

1.

Borrowed resources/capital must be repaid at specified

future dates, usually with interest. Debt is temporary
financing.

2.

The consequences of a failure to repay debts and related

interest on a timely basis can be harsh (i.e. bankruptcy or
foreclosure)

3.

It can be difficult to qualify for.

Option 1: Borrow resources from creditors or lenders.

(Debt Financing)
Option 2: Contributions from investors/owners.
(Equity Financing)
The "financing" of a business has to do with how capital is
obtained for a business.

5.

6.
1-1

Characteristics of Equity Financing

1. Investors contribute resources/capital in exchange for
ownership interests in a business. In a corporation this
ownership is evidenced by shares of stock. Ownership
typically grants the following rights:

The Key Advantage of Debt Financing:

- No sacrifice of ownership rights (voting, profit sharing)

A. A right to vote or have a say in the affairs of the

business.
B. A right to share in any profits of the business. This
cost of capital could be very expensive.
C. A right to share in any remaining resources in the
event of business termination.

The Key Advantage of Equity Financing:

- No requirement to repay the capital contributed.

2. Investor contributions of resources are not subject to

repayment at a future date and there are no interest charges.
Equity financing is permanent financing.

7.

8.

How does an owner/investor get their investment back if the

business has no obligation to repay the contributed capital?
1.

2.

The Two Ways Owner/Investors Make

a Profit/Loss on Investment

Distributions upon discontinuance of the business - If a business

terminates, any excess resources of the business after the payment of all
debts are distributed to owners. There is no assurance this distribution
will be the same as the amount invested. If it results in a higher or
lower amount, the investor realizes a gain or loss on investment,
respectively.

1. Sharing in the business operating profits.

Distributions of resources created through profitable
operations to owners is referred to as a dividend.

Subsequent sale of ownership interests to other investors - Original

investors of capital in corporations receive shares of stock as evidence of
their ownership interests and rights. This stock can be subsequently sold to
other investors, usually through a stock exchange (ie. NYSE, NASDAQ,
etc.). The amount received upon sale may be more or less than the amount
originally invested resulting in capital gains or losses for the investor.

2. Capital gains or losses on the sale of stock or

distributions upon the termination of the business.

9.

10.

Most Investors and Creditors Require

Information for Their Investment Decisions

Financial vs. Managerial Accounting

Financial Accounting seeks to provide information to current or future
providers of capital (investors or creditors) and other interested parties
outside of management (ie. government regulatory bodies). This is
accomplished through periodic general purpose financial statements
which provide summarized historical information on the company's
financial position and results of operations.

- Creditors want to evaluate a company's credit worthiness.

"Will the business be able to repay the debt plus interest on
a timely basis?"
- Investors want to evaluate the profit potential of an
investment in a company's stock. "What are the
possibilities that stock will increase in value or that there
will be substantial dividends in the future?"

Managerial Accounting seeks to provide information to assist

managers in the effective operation of a business. This is accomplished
through customized management reports that tend to be more detailed in
nature and may include future budgets and forecasts as well as historical
data. These reports are not generally available to the public and seek
only to improve management's future performance.

The primary purpose of financial accounting is to provide

information that assists investors and creditors in such
evaluations.

11.

12.
1-2

Financial Accounting's Focus is the General

Purpose Financial Statements
1. Balance Sheet or Statement of Financial Position

Two critical conditions must exist for financial

statements to be truly useful.

2. Income Statement or Statement of Operations

1. Comparability
2. Credibility

3. Statement of Cash Flows

These financial statements can be found in a company's annual
report which is readily available to the public. To prove this,
you are to complete the Financial Statement Review
Assignment as noted in the syllabus.

13.

14.

-Generally accepted accounting principles (GAAP) are the rules and standards
of accounting used to create comparable of information.

Two critical conditions must exist for financial

statements to be truly useful.

-This need for GAAP became obvious with the stock market crash of 1929.
There were no generally accepted accounting principles or standardized
information requirements before the crash.

1. Comparability

-In response, Congress created the Securities and Exchange Commission (SEC)
to regulate the capital transactions of publicly-held companies.

2. Credibility

Credibility refers to the need for the financial

statements to provide information that is materially
accurate and reliable.

-The SEC has the legal authority to determine GAAP for publicly-held
companies, but originally delegated that responsibility to the American Institute
of Certified Public Accountants (AICPA).
-In 1973, a new private organization, the Financial Accounting Standards Board
was formed to assume the responsibility for establishing GAAP.
-The FASB is subject to some political pressure given the authority of the SEC.

15.

16.

UPDATE
-A company's management is responsible for its accounting system and the
preparation of its financial statements.

At the time this lesson was originally produced there was relatively
little going on in the area of international accounting standards.
However, today over 100 countries accept and use standards
established by the International Accounting Standards Board (IASB)
operating out of London, England. These standards are referred to as
International Financial Reporting Standards or IFRS and in some
cases they are very different from US GAAP.

-Management may have conflicts of interest in the accurate preparation of the

statements.
-Materially innacurate financial statements are at best worthless and at worst,
may actually deceive and severely damage the user of financial statements.
-As a result, the SEC requires that all financial statements of publicly-held
companies be subject to outside independant audit for accuracy by an
independent certified public accounting firm (CPA).

Recently, the FASB and IASB joined together recognizing the growing
need for common world-wide standards and agreed to participate in a
joint effort to reconcile the differences between US GAAP and IFRS.
This process, known as convergence, is progressing today on an active
basis.

-The CPA must issue an auditor's report which must accompany a company's
financial statements and clearly state the material reliability of the information
and its compliance with GAAP.

17.

18.
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UPDATE
(Continued)

UPDATE
(Continued)

It is now clear that the world is pushing towards a single set of

converged standards that will ultimately be used by all countries
including the U.S. In fact, in 2008 the SEC began allowing foreign
companies to trade their stocks and bonds on U.S. exchanges using
IFRS. In addition, the SEC is considering some future deadline in
which all companies will be required to use converged international standards in their financial reporting.

It is now clear that the world is pushing towards a single set of

converged standards that will ultimately be used by all countries
including the U.S. In fact, in 2008 the SEC began allowing
foreign companies to trade their stocks and bonds on U.S.
exchanges using IFRS. In addition, the SEC is considering some
future deadline in which all companies will be required to use
converged international standards in their financial reporting.

Fortunately, for this Introduction to Accounting; The Language of

Business most of the material included in the lessons is the same
under both U.S. GAAP and IFRS. When current differences exist
they will be noted along the way.

Fortunately, for this Introduction to Accounting; The Language

of Business most of the material included in the lessons is the
same under both U.S. GAAP and IFRS. When current differences
exist they will be noted along the way.

19.

Federal Agencies
SEC
(Securities &
Exchange
Commission)

20.

Federal Agencies

Publicly-Held
Companies
Regulate
Stock & Bond
Transactions

Publicly-Held
Companies

SEC
(Securities &
Exchange
Commission)

Annual Report
(and other
information)
Investors
&
Creditors

IRS
(Interal
Revenue
Service)

Annual Report
(and other
information)
Collect Income
Taxes

Investors
&
Creditors

21.

Publicly-Held
Companies

Annual Report
(and other
information)
Investors
&
Creditors

22.

Private Organizations

Publicly-Held
Companies

AICPA
(American Institute
of Certified Public
Accountants)

Annual Report
(and other
information)

License and Certify

Investors
&
Creditors

CPA's

23.

Private Organizations
AICPA
(American Institute
of Certified Public
Accountants)

Establish Rules of
How to Conduct an Audit

Audit

CPA's

24.
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Publicly-Held
Companies

What Do CPAs Do?

1. Exclusive right to perform audits of financial statements.
2. Tax advice and preparation of various kinds of tax returns.

Annual Report
(and other
information)

3. Business consulting and advice:

1. Information systems design and implementation.
2. Performance or operational audit.
3. Business valuations.
4. Mergers and business acquisitions.
5. Fraud auditing and internal control reviews.
6. Personal financial planning and investment advice.

Investors
&
Creditors

Private Organizations
AICPA
(American Institute
of Certified Public
Accountants)

Create GAAP
(Standards of Accounting)
FASB
(Financial
Accounting
Standards Board)

25.

26.

FYI
By the way, CPAs are also sometimes called upon to perform audits
of privately-held or non-public companies. These companies
sometimes require an audit if they have plans to go public in the
future or need current financing. Companies planning to go public
may need as many as three years of audited financial statements
before receiving SEC permission to go public, although the SEC
does provide certain exceptions for smaller businesses. As far as
other financing is concerned some private investors, banks or other
lenders may require audited financial statements before making their
investment or lending decisions.

In 2002, following a number of highly publicized financial statement

frauds, Congress passed the Sarbanes-Oxley Act, known as Sarbox.
This legislation created a higher level of federal regulation over CPAs
and the audits they perform on publicly held companies. Thats done
through an organization called the Public Company Accounting
Oversight Board or PCAOB, which is overseen by the SEC.
This board has a broad mandate to promote audit quality and protect
the public interest through its authority to set audit standards, conduct
inspections of CPA firms performing audits of publicly held companies, initiate enforcement actions, and impose penalties on those firms
not meetings certain standards. In short, Sarbanes-Oxley reduced the
role of the AICPA in regulating their member CPAs performing audits
of publicly held companies and increased the role of the federal
government through the SEC and the PCAOB.

For audits of private companies with no immediate plans to go

public the federal government has no regulatory authority. Therefore,
the AICPA continues to provide standards and oversight of CPAs
performing such audits.

27.

28.

Lesson Summary

The Value of an Accounting Education

What is a business? (Manufacturing, Merchandising, Service businesses)

Successful businesses need:
-Good Idea
-Capital
-Management Skill
Two ways businesses access capital:
1. Borrow it.
2. Investment from owners/investors.
Investors and creditors need infromation in making their capital
investment decisions.
Financial accounting seeks to provide financial statements for
investor and creditor use in those decisions.
Useful financial statements must be comparable and credible.
GAAP, established by the FASB, provides the key to comparable
financial statements among differing companies.
CPA audits required by the SEC for publicly-held companies seek to
insure financial statement credibilty.

- Studying and understanding the language of business and

understanding the kinds of information available to decision
makers (investors, creditors and management) is great
preparation to become a business decision maker.
- Career opportunities in CPA firms.
- Partner/Ownership in large international firms or small
local firms
- Stepping stone to other opportunities:
CFO, CEO and other management positions
Entrepreneurship

29.

30.
1-5

"Overall, an accounting education

provides a better foundation for
running a business than that of any
other profession."

- Some students enter directly into business, usually in a

company's accounting, finance, internal audit and information
systems department. With time and promotions, management
opportunities arise along with opportunities to move within a
business to other disciplines.
- An accounting education provides a great base for:
- A career in finance, investment banking, stock brokerage
and personal financial planning.
- Continuing education (Law School, MBA, MPA)
- A career in teaching
- Government service: FBI, IRS, GAO, other state and
local.

Robert R. Woodson
President of
John H. Harland Co.

31.

Business Ownership:
Three Basic Legal Forms

32.

3. Corporation: A separate legal entity apart from its owners

- Legal red tape in formation and operation imposed by the state.
- One or more owners. A corporate form of business greatly
facilitates many owners and the transfer of ownership interests.
- Separation of business and personal liability of owners.
- Seperation of business and personal taxation (double taxation)

1. Proprietorship:
- One owner.
- No legal red tape except if employees hired.
- No seperation of business and personal legal liability. (This
can be addressed through insurance.)
- No separate income taxation.

Effects of Separate Corporate Taxation

2. Partnership: Same as proprietorship except there is more than

one owner.
- No legal red tape except if employees hired.
- A formal partnership agreement is recommended but not
required.
- No separation of business and personal liability.
- No separate income taxation.

$10 million
x 36%
$6.4 million
x 40%
$3.8 million

Profit
Corporate federal income tax
After tax corporate profit paid as a
dividend to owners
Personal federal income tax
Owners' after tax return on investment

33.

Example of Double Taxation

34.

Example of Double Taxation (continued)

Assume that after years of effort a business begins to operate successfully and
generates a $1,000,000 profit in the current year. If that business operates as a
proprietorship, the $1,000,000 of profit is then included in the owners personal income
tax return and taxed at his or her personal rate. If we assume a federal income tax rate
of 28% and a state rate of 7% then the 35% combined rate would result in a $350,000
tax payable which leaves $650,000 as the net after-tax profit to the owner. By the way,
as mentioned previously, partnerships are taxed similar to proprietorships in that their
profits are allocated to the partners and then included in their personal income tax
returns. There is no separate or additional tax charged to the partnership.

This is the double taxation that comes with operating a business in the form of a
corporation. In this example the end result is that only $493,000 is left to the owners
after the payment of all taxes.
This raises the following question. Is there any way to legally avoid some of these
taxes --- at least the effect of double taxation associated with corporations? The
answer is yes.
One approach is through the use of salaries and bonuses as a way of distributing
profits to owners rather than dividends. In other words, if you simply took the
$1,000,000 of total profit and paid it all out to the owners as a salaries and bonuses
then the business would have zero net income given that such salaries and bonuses are
deductible expenses of the business. The $1,000,000 of profit less $1,000,000 of
salaries and bonuses to the owners leaves zero net income and zero corporate income
tax payable. In that case the only income taxes payable would be the amount due on
owners based on salaries and bonuses received.

On the other hand, if this business operates as a corporation then its profits are taxed
first at a corporate rate before an additional tax is charged to the owners on any
distribution of the remaining profits. For example, using the maximum federal
corporate income tax rate of 35% and an assumed 7% state income tax rate the
combined 42% would result in a $420,000 corporate income tax payable on the
$1,000,000 of profit. That leaves $580,000 for the owners which is then taxed again if
its distributed as a dividend. Dividend income is currently taxed at a 15% federal rate
which means an additional $87,000 tax payable by the owners.

35.
1-6

36.

Example of Double Taxation (continued)

Example of Double Taxation (continued)

Another possibility is the relatively new and popular form of ownership referred to
as Limited Liability Corporations or LLCs. This form of ownership provides
separate legal liability for owners but is otherwise treated like a partnership for tax
and other purposes. This allows for the avoidance of double taxation but can
create some other issues worth considering. For example, the transfer of
ownership interests in LLCs are much more problematic than in regular
corporations. For example, if a particular owner in an LLC wishes to sell an
interest, the transfer of that interest must receive the full approval of all of the
other owners. That is not the case in a regular corporation. In addition, if an
owner dies the business must then be dissolved and reformatted before it can
continue. In short, there are some problems associated with LLCs; however, it is
a popular and fast growing form of business ownership in that it creates separate
legal liability for owners and avoids the problem of double taxation.

Unfortunately, the IRS knows that corporations can do this to avoid the effect of
double taxation. As a result, any amount paid to owners for salaries and bonuses
must be reasonable relative to the amount of services they provide. In other
words, if an owner provides no work or other services to the business then no
salary or bonus is allowed. However, these determinations can be subjective and
in many cases the final amount allowed is based on a negotiated agreement with
the IRS.
Another approach that is commonly used to eliminate the effect of double taxation
is referred to as the Subchapter S Election under the Internal Revenue Code.
This election was originally designed for smaller growing companies and
provides for corporations with relatively few shareholders to be taxed as if it were
a partnership. In other words you may still operate as a corporation with separate
legal liability between the business and the owners but the income of the business
is taxed directly to the owners without the imposition of a separate corporate tax.
But, again, this Subchapter S Election is limited to only certain companies having
relatively few shareholders.

Clearly from this discussion, the choice of a legal form of business can be
somewhat complicated. In most cases, additional study and some legal counsel
may be necessary before making this decision.

37.

38.

Corporate Ownership, Governance

and Management

- The Board of Directors acts on behalf of the company in the hiring of senior
management personnel and makes other strategic decisions for the business.

- States authorize the formation of separate corporate entities.

- Senior Management is accountable to the Board, and therefore the owners, and
is responsible for the business operations in an effort to maximize profits for the
benefit of the owners. Management may or may not own shares themselves.

- Articles of Incorporation and By Laws created by the founder(s) and

filed with the state determine how the corporation will be governed.

Shareholders (Invest Capital)

- Corporate ownership is evidenced by stock certificates (shares of stock).

Elect

Board of Directors (Advise for a fee)

- Shareholders/Owners have the right subject to the by-laws to vote on

corporate matters (one vote per share) and the right to share in dividends
on an equal per share basis. (A shareholder's influence and percentage
participation in profits depends on how many shares are owned and how
many shares are outstanding.)

Hires

Top Management Personnel (Manage for a salary)

Hires

Other Employees (Work for a salary/wage)

- Corporations are governed on a representative basis through a Board of

Directors elected by shareholders. Directors need not be shareholders
and are often compensated for their work.

Produce Profits for Owners

39.

40.

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Lesson 1 problems/answers
Problem #1

A. Why is accounting sometimes referred to as the "language of business?"

Accounting is the language of business because it seeks to communicate information to those who are interested in a business.

Respond briefly to the following questions:

A. Why is accounting sometimes referred to as the "language
of business"?

B. What is financial accounting as opposed to managerial accounting?

Financial accounting seeks to provide information to those who are
external to the day to day operations of the business. External users
include investors and creditors, government regulatory bodies, labor
unions, the media and other users external to the management of the
business.

B. What is financial accounting as opposed to managerial

accounting?
C. Why would an investor considering an investment in the
stock market find financial accounting information of value?

Managerial accounting is the providing of information to management,

those who are internal to the business.

D. What is GAAP? Does it apply to managerial or financial

accounting or both? Why is GAAP so important?

33.

C.

34.

Why would an investor considering an investment in the stock

market find financial accounting information of value?

Problem #2

In order to make intelligent and informed investment decisions,

investors need current information on a companys financial position
and results of operations as a basis for projecting its future investment
potential.
D.

Respond briefly to the following questions:

A. What are the SEC, FASB, AICPA and IRS? Describe the
general purpose of each.

What is GAAP? Does it apply to managerial or financial

accounting or both? Why is GAAP so important?

B. What kinds of businesses must have external audits performed

on their financial statements and why?

GAAP stands for "Generally Accepted Accounting Principles,"

which are the standards by which accounting information is prepared
and presented to external users. GAAP applies only to financial
accounting information. GAAP is important because it helps create
comparable information among companies seeking capital and
allows investors and creditors to make more informed investment
decisions.

C. Who has exclusive authority to perform external audits?

D. What advantages would be had for global business if there were
international standards for GAAP?

35.

36.

The answer

Problem #2

The answer

Problem #2

B.

A. What are the SEC, FASB, AICPA, and IRS? Describe the general purpose
of each.

What kinds of businesses must have external audits performed on their

financial statements and why?
Businesses which seek to acquire capital from the public must provide audited
financial statements. The SEC requires such companies to provide financial
statements prepared in accordance with GAAP and subjected to independent
audit by a Certified Public Accountant.

SEC (Securities and Exchange Commission) - Federal agency charged with the
responsibility of regulating the capital markets (debt and equity investments) for
publicly held businesses.
FASB (Financial Accounting Standard Board) - Private institution which
currently determines GAAP.

C.

Who has exclusive authority to perform external audits?

Certified Public Accounting firms

AICPA (American Institute of Certified Public Accountants) - Private national

organization of CPA's. The AICPA assists states in the CPA certification process
by administering a national examination, establishes standards of auditing and
professional conduct for CPA's and encourages compliance with those standards.

D.

What advantages woud be had for global business if there were international
standards for GAAP?
If all countries required the same, high-quality standards of accounting, then
financial information for businesses worldwide would be comparable and
global capital markets would be improved. Investments of capital worldwide
would have lower risk and the cost of capital would be reduced. High quality
international GAAP would ultimately improve the worldwide economy.

IRS (Internal Revenue Service) - Federal agency charged with the responsibility
of federal tax collection.

37.

38.
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Problem#3
Read the following and respond to the questions provided:

Fraud Victims
MiniScribe, a computer disk-drive manufacturer was in a mighty big hurry. After seven
consecutive quarters of record-breaking profits, and the quintupling of its stock value
over the last 18 months, this was a company on a roll. In fact, the company was
desperate for more cash in its rush to grow and was expediting efforts to raise $100
million through the issuance of bonds.
After a somewhat frantic effort, the required financial statements and forms were
completed and filed with regulators along with a clean audit report. The bonds were
issued and the future seemed assured. Life was sweet for management and investors
alike.
Unfortunately, MiniScribe's superlative record was actually more fantasy than fact.
Within four years of the bond sale the company was forced to file bankruptcy and
liquidate assets ultimately repaying bondholders less than $.50 on each original $1.00
invested. Subsequent investigations revealed that the financial statements previously
certified as accurate by the prestigious accounting firm of Coopers & Lybrand had been
grossly overstated. Fake sales and phony shipments to phantom customers and other
schemes had gone undetected as management perpetrated a massive fraud on its investors
and creditors. Lawsuits filed on behalf of bond and stockholders brought claims totaling
hundreds of millions of dollars against MiniScribe's former chairman, Q.T. Wiles; the
company's investment bank, Hambrecht & Quist; and Coopers & Lybrand.
Malpractice suits against accounting firms are a common event in todays business world.
As more companies fail and stock values plummet investors are looking for someone to
blame and cover their financial losses. In recent years, virtually all of the large
international CPA firms have paid out millions to settle investor claims that they were
more interested in the companies that paid their audit fees than the investors who relied
on their work. Recent settlements over accounting malpractice "call into question the
entire audit process," says John Shank, an accounting professor at the Amos Tuck school
of business at Dartmouth College. At issue is the ability of auditors to serve the public
interest given their inherent conflict of interests.
Court documents indicate that the partners at Coopers Denver office responsible for the
Miniscribe audit were feeling significant economic pressure themselves. With a general
economic downturn and settlements on other audits gone wrong, the firm was sensitive to
customer satisfaction. MiniScribe was an important office client. As a result, a
willingness to go along with management or overlook certain accounting irregularities
may have prevailed.

Coopers claims it was also deceived by "a massive and collusive fraud" and that "any
failures on its part were based on information deliberately misstated by MiniScribe."
They deny any wrong doing in the audit and asset that they properly followed all required
professional standards in the performance of their work. In fact, an investigation
instigated by MiniScribe's outside directors determined that Coopers had indeed been the
victim of management fraud. Accountants in the profession agree that auditors must rely
on certain management representations and disclosures in the performance of any audit
and that collusive management fraud can undermine and mislead even the best audit
procedures. By their very nature audits involve subjective analysis and as Coopers
attorney, James P. Linn, says "there isn't an audit ever done that a good lawyer or the
experts he hires couldn't take apart later in court." However, Coopers own work papers
indicate that Coopers made a number of judgments in their audit work that other
accountants might consider questionable under standard auditing procedures recognized
by the profession. "The red flags at MiniScribe . . . were so numerous that only a blind
man or someone in on it could miss them," says Paul Regan, a fraud expert hired to
testify on behalf of Hambrecht & Quist.
Court records indicate that MiniScribe management was actively involved in expediting
an unusually high volume of year-end sales and other accounting adjustments to reach a
targeted net income figure. It appears that time pressures and general management
resistance were contributing factors in Coopers failure to detect much of the fraudulent
reporting. Mr. MacFee, the head of the Coopers audit team, testified that MiniScribes
chairman, Mr. Wiles, once called him and became "agitated" about Coopers concerns as
to what should actually constitute a sale. Mr. MacFee said that at one point he was forced
to hold the telephone away from his ear due to Mr. Wiles's rantings.
Although Coopers & Lybrand hold to their claim that they too were victims of a massive
and collusive fraud, a jury awarded MiniScribe's bondholders more than $550 million in
damages. Of that, $200 million was punitive damages for Coopers & Lybrand's
negligence in the conduct of the audit. (Coopers later settled for between $45 million and
$50 million, according to people familiar with the settlement.) Coopers also reportedly
settled with MiniScribe stockholders, bankers and suppliers for a comparable amount.
(Elements taken from 5/14/92 Wall Street Journal article entitled Numbers Game by Lee Berton.)

A. Who sued whom and why?

B. What is an auditor's report and why is it important?
C. Why should auditors be independent?
D. Can auditors be truly independent and why?

Problem #3 Answer
A. Who sued whom and why?
This article refers to lawsuits filed by bond and stockholders of MiniScribe against the
company's management, investment banking company and the CPA firm that audited the
financial statements. Bondholders, relying upon the information provided in the financial
statements, loaned approximately $100 million to MiniScribe. The financial statements
proved to be materially misstated and the bondholders and stockholders ultimately lost a
large part of their investment when the company subsequently failed.

B. What is an auditor's report and why is it important?

The auditors report is an independent verification as to the material accuracy of the
financial statements. This report is critical because without it the financial statements
have no credibility - no one can rely on them.

C. Why should auditors be independent?

Auditors need to be independent because investors and creditors are going to rely on the
auditors opinion relative to the accuracy of the financial statements.

D. Can auditors be truly independent and why?

Because companies pay their auditors there is always a conflict of interest. Auditors may
be tempted to ignore management misstatement of the financial statements to maintain
relations with management and secure future audit fees. However, as the MiniScribe
article describes, such auditors face the risk of investor lawsuits and sanction or loss of
license by the SEC and AICPA.