Critical examinations of recent corporate scandals that have occurred—i.e. Enron and WorldCom in particular—demonstrate that the accounting practices utilized by the organization were less than ethical. However, in most instances the accounting principles used by the organization were legal. For instance, Enron utilized special purpose entities or SPEs as a central means to hide much of the organization's debt. While the use of SPEs is not illegal per se, the fact that the organization withheld critical information from its investors represents a notable breech of trust between the organization and its investors.
Interestingly, the methods used by Enron and other organizations to hide debt are not always considered illegal when it comes to the accounting rules and principles that have been established by the Securities and Exchange Commission (SEC). As such, investors must now garner a more integral understanding of the specific procedures that are being utilized by organizations to improve the overall luster of their financial statements. In many respects, investors have entered into an era of caveat emptor, in which they must employ an acute understanding of what specific accounting terms mean and how these practices impact the overall development of financial statements produced by the organization.
[...] Even though current trends demonstrate that banking organizations are using decreases in loan loss reserves as a plausible means to increase profits and remain competitive, the current research also suggests that this process is one that may shift in coming months. Rieker (2005) in his examination of the use of loan loss revenues to boost overall profits argues that as credit costs for banks begin to rise, the profits that have been posted as a result of using loan loss reserves will be eroded. [...]
[...] Unfortunately, when the issue of using loan loss revenues to boost profits is examined in terms of the overall legal ramifications of the practice it is clear that there are no real legal statues in place to prohibit this type of activity. In fact, as noted by Stone (2005) the SEC allows organizations to shift loan loss revenues to profits as long as the shift can be justified. In recent years, the number of organizations making this shift has, in essence, created a precedent that now makes it easier for organizations to justify shrinking their loan loss revenues in favor of remaining a competitive investment for investors. [...]
[...] Using Loan Loss Revenues—Recent Cases Stone (2005) in his examination of using loan loss revenues as a means to enhance earnings management notes how banks are currently utilizing this process as a means to enhance their overall profitability and performance. According to this author, small regional banks, such as Detroit's Comerica Inc., as well as larger national banks, such as Citigroup, have begun using loan loss revenues to improve their overall financial statements for investors. As noted by Stone, banks use loan loss revenues as follows: All they had to do was allocate a little less money to loan-loss reserves—the money they set aside to cover bad debt. [...]
[...] Examining the particular issue of using loan loss reserves as a method for earnings management, the following has been reported with respect to this banking organization. In the second quarter of FY2004, the organization added only $20 million to its loan loss reserve, instead of its typical $74 million. Through this process, the organization was able to boost its “bottom line by about $39 million—or eight cents of its per-share profit of 70 cents, or $291 million. Without that, KeyCorp would have fallen about two cents short of Wall Street profit targets” (p. [...]
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