S12 WS Q1-a If management reports truthfully, what economic events are likely to prompt the following accounting changes?

Increase in the estimated life of depreciable assets. Managers may increase the estimated life of depreciable assets when they realize that the assets are likely to last longer than was initially expected. For example, Delta Airlines extended the estimated life of the Boeing 747, a relatively new product, by 5 years when Delta found out that some of the first Boeing 747s manufactured were still flying in commercial service. Excellent maintenance and less usage than initially expected may also prompt corporate managers to extend the estimated life of depreciable assets. Decrease in the allowance for doubtful accounts as a percentage of gross trade receivables. The firms change of customer focus may prompt managers to decrease the allowance for uncollectible receivables. For example, when a firm gets large sales orders from reliable (low default risk) customers such as Tesco and Volvo, it does not have to reserve the same percentage of allowance used for small (or high default risk) customers. Recognition of revenues at the point of delivery, rather than at the point cash is received. Revenues can be recognized when the customer is expected to pay cash with a reasonable degree of certainty. Suppose that a company re-evaluated its customers credit and found out that its customers financials improved significantly. In dealing with that customer, the company can recognize revenues at the point of delivery rather than at the point when cash is received, because the risk of cash collection is no longer significant. Capitalization of a higher proportion of development expenditures. According to IAS No. 38, costs incurred on product development (after the establishment of technical feasibility and commercial feasibility) are to be capitalized. Technical feasibility is considered to be established when the firm has completed a product design. Commercial feasibility is established when the uncertainty surrounding the development of new products or processes is sufficiently reduced. If the company completes the product design earlier than it initially expected, it can capitalize a higher proportion of development costs during that period. Q1-b What features of accounting, if any, would make it costly for dishonest managers to make the same changes without any corresponding economic changes? Third-Party Certification. Public companies are required to get third-party certification (auditors opinion) on their financial statements. Unless the accounting policy changes are reasonably consistent with underlying economic changes, auditors would not provide clean auditors opinion. A qualified auditors opinion will penalize the company by increasing its cost of capital. Reversal Effect. Aggressive accounting choices may inflate net profit in the current period but they hurt future net profit due to the nature of accrual reversal. For example, aggressive capitalization of software R&D expenditures may boost current period earnings but it will lower future periods net profit when the capitalized costs have to be subsequently written-off. Investors Lawsuit. If a company disclosed false or misleading financial information and investors incurred a loss by relying on that information, the company may have to pay legal penalties. Labor Market Discipline. The labor market for managers is likely to penalize individuals who are perceived to be unreliable in their dealings with external parties.