Search the Internet for a publically traded company that recently restated its financial statements. State the Company that you are evaluating and the most recent period for SEC filings.
Write a 3-4 page paper in which you: 1. Discuss the primary reason for the restatement and the impact to the financial results for the company you selected. 2. Discuss ?management? responsibility to the investors and stakeholders for the financial restatement. 3. Discuss what changes you would expect the company leadership to make related to internal controls, accounting principles, or other initiatives as a result of the need to restate the financial statements. 4. Discuss the impact to the ?trustworthiness? of the company?s leadership team based on the need to restate the financial statements. 5. Use at least four (4) quality resources in this assignment………………..
CKE Restaurants Case Study
The recent financial scandals at WorldCom and Enron which were publicly-traded firms led to the establishment of Sarbanes-Oxley Act of 2002 which recommended that the firms to document and review their internal controls in financial reporting (Ge and McVay, 2005). As a result of the process of reviewing, some other firms came to the discovery of errors in their previously reported financial statements which was in dire need of restatements. In 2004 Security Exchange Commission (SEC) received files from CKE restaurants which were giving reasons as to why they had to restate their financial statements. This paper will analyze the reasons for restatement and the impact to the financial results, the expected changes the leadership would take relating to internal controls and accounting principles and the trustworthy of the leadership team in the firm on the basis of the restatements.
Primary reasons for the restatements and the impact to the financial results for the firm
Accounting for operating leases
SEC issued in February, 2005, a letter to make clarification of the interpretation of some operating lease related accounting standards. Focus was drawn towards three main subjects who were; improvement of leasehold amortization with the presence of lease renewal points in a lease, realization of rent expenditure when the lease has a free rent periods and the method used to book landlord incentives as paid in by the tenant (smith, 2005).
In the improvements of leasehold amortization, lessee is given initial lease term and the option for renewal. Such circumstances may allow or may not allow the lessee to exercise the lease option. CKE restaurant and other firms have continuously misapplied the accounting standards for lease through making preposition that the renewal option in the future, would be implemented hence taking the initial lease term and adding to the period of renewal which the amortization of the leasehold improvement was conducted. The letter form SEC states that leasehold improvement amortization over an elongated time period reduces the annual amortization expense. Further clarification were made in the Financial Accounting Standards Board (FASB, 1988)
A lot of the restatements in the firm were not reliable because they used the lease terms in two separate dimension of accounting for lease. Furthermore, in assessment of whether the lease was supposed to be treated as a capital lease or an operating lease the firms failed to make an inclusion of option periods in the lease term. The correct accounting for rent holidays was also addressed by the SEC letter which stipulated the application of the straight-line method of realizing expenses related to rent. Any rent increase was to be designed to give an incentive for the lessee to meditate on the expected impact of inflation to ease the near term cash flow needs of the lessee (Rapoport, 2005). This would enable the lessee to acknowledge the time value for money. Furthermore, the impact of the increase in rent must be included in the minimum payments for the lease. This must be recognized by both lessee and the lessor on a straight line basis over the period of the lease term. Time value for money and the projected inflation rate factors may not be appropriate to create a connection with the physical usage of the leased property.
Managers’ responsibilities towards investors
Most of the restatements were discovered to be intricate of internal auditors and managers and that the focus on quality by management and regulators such as to meet the standardized disclosure prerequisite by SEC. The firms’ and the management of CKE together with other firms were no longer to depend on reporting financial statements in the form of 8-K. the management had a responsibility to comply with the disclosure requirements of the latest form of 8-K to be in a consistent to the guidelines set by SEC. hence all financial reports were to be harmonized accordingly. The management at that time then increased investor’s confidence in the U.S capital markets due to stabilization of share prices. Besides, the internal auditing and external auditing as part of the management watch dogs had a duty to ensure conformity to the regulatory enforcement which related to the process of auditing and accounting.
The impact to the trustworthiness of the company’s leadership team
Since many companies had to restate their financial statements, as a result of improper accounting on leases, many people saw it as a way of managing earnings by the firms. This resulted into great success of earnings management due to the strong team leadership that collectively agreed to the methods put forward by the SEC (Nelson, Elliott & Tarpley 2002). With the structured transactions, in clear accounting principles and well established accounting standards, managers collectively succeeded in reporting good returns about the firm as a result of restatement of financial statements. In common the restaurant business served up more restatements, which led to critical scrutiny of all leases and the methods of accounting hence enabling them to trim their past profits (Hughes, 2005)
The task has addressed the latest increase in restatement of financial statements in CKE restaurants as a result of inappropriate methods of accounting for lease. The changes in leadership as in relation to the restatements have been discussed. The credibility of the management during the restatements in connection to the official accounting pronouncements regarding leases has been evaluated in connection to CKE restaurant. It is clear that the substantiation with the assumption in connection to accounting for lease, CKE restaurant that made a restatement were not purposefully misapplied under the GAAP, but rather the commitment to their commonly used practices in their industry.
Financial Accounting Standards Board (FASB) (1988). Issues Relating to Accounting for
Leases, FASB Technical Bulletin No. 88-1. Norwalk, CT: FASB
Financial Accounting Standards Board (FASB) (1988). Accounting for Leases, Statement of
Financial Accounting Standards No. 98, Norwalk, CT: FASB.
Ge, W. & S. McVay (2005). The disclosure of material weaknesses in internal control after the
Sarbanes-Oxley Act Accounting Horizons, 19(3), 137-158.
Hughes, S. (2005, March 2). Many companies move to clean up lease accounting. The Wall
Street Journal, C1. Jones, S.D. & R. Gibson (2005, January 26). Restaurants serve up restatements; more scrutiny of leases is leading some chains to trim their past profits. The Wall Street Journal, C3.
Nelson, M.W., J.A. Elliott & R.L. Tarpley (2002), Evidence from Auditors about Managers’ and
Auditors’ Earnings Management Decisions, the Accounting Review, 77(Supplement), 175-202.
Rapoport, M. (2005, November 18). Lease accounting draws scrutiny. The Wall Street Journal,
Smith, E.B. (2005, January 5). Restaurants have accounting trouble with leases. USA Today, 3b.
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