FRA - Red flags

[siidheart]

Q Which of the following will most likely result in lower financial reporting quality?
A Engaging in fraudulent financial reporting.
B A low allowance for uncollectable accounts receivables.
C Selecting alternatives within accepted accounting principles that distort results to achieve a desired outcome.

According to the readings, C is straightforward. But why cannot B also cause lower financial reporting quality? And fraudulent reporting is lower quality indeed??

 

[shootforthestars1]

Tricky one- leme give it a shot.
Quality vs Fraud: Fraud is to do with outright lying but quality is to do with using what are otherwise correct figures and twisting the information/rules in a way to achieve a desired outcome, e.g. to meet a covenant requirement or favourable leverage ratio, etc
Why not B: Well because this involves judgement/estimate and the word “low” isn’t a confirmation of either fraud or lower quality.

 

[cpk123]

you have a low allowance for uncollectable account receivables - which means you are stating inherently that a lower proportion of your receivables will NOT be collected. So anything above that will be recognized as a loss - and you will report it as such. So a lower allowance - means you will have higher write offs on uncollected account receivables - and you will report that write off, without hiding it. So your financial reporting quality will actually be better.

 

[shootforthestars1]

Good explanation - cheers!

 

[sks2013]

nice explanation..

 

[sglondon]

cpk123 wrote:
you have a low allowance for uncollectable account receivables - which means you are stating inherently that a lower proportion of your receivables will NOT be collected. So anything above that will be recognized as a loss - and you will report it as such. So a lower allowance - means you will have higher write offs on uncollected account receivables - and you will report that write off, without hiding it. So your financial reporting quality will actually be better.

I believe you misread the question - Uncollectible allowance (contra account which is a credit to AR) is understated, therefore the net AR balance is too high. So the reality is actually the opposite of whatyou described.
Secondly, overstated uncollectible AR (and thus write-offs) does not improve financial reporting quality, it’s just as incorrect as an understated allowance….

 

[SHoot85]

sglondon wrote:

cpk123 wrote:
you have a low allowance for uncollectable account receivables - which means you are stating inherently that a lower proportion of your receivables will NOT be collected. So anything above that will be recognized as a loss - and you will report it as such. So a lower allowance - means you will have higher write offs on uncollected account receivables - and you will report that write off, without hiding it. So your financial reporting quality will actually be better.

I believe you misread the question - Uncollectible allowance (contra account which is a credit to AR) is understated, therefore the net AR balance is too high. So the reality is actually the opposite of whatyou described.
Secondly, overstated uncollectible AR (and thus write-offs) does not improve financial reporting quality, it’s just as incorrect as an understated allowance….

imo, the question doesn’t specify “understated” as you say, it just says it’s low. it doesn’t imply it is wrong to be low, ie. the company may traditionally collect a high % of their AR. that’s the way I see it anyhow.

 

[sglondon]

SHoot85 wrote:

sglondon wrote:

cpk123 wrote:
you have a low allowance for uncollectable account receivables - which means you are stating inherently that a lower proportion of your receivables will NOT be collected. So anything above that will be recognized as a loss - and you will report it as such. So a lower allowance - means you will have higher write offs on uncollected account receivables - and you will report that write off, without hiding it. So your financial reporting quality will actually be better.

I believe you misread the question - Uncollectible allowance (contra account which is a credit to AR) is understated, therefore the net AR balance is too high. So the reality is actually the opposite of whatyou described.
Secondly, overstated uncollectible AR (and thus write-offs) does not improve financial reporting quality, it’s just as incorrect as an understated allowance….

imo, the question doesn’t specify “understated” as you say, it just says it’s low. it doesn’t imply it is wrong to be low, ie. the company may traditionally collect a high % of their AR. that’s the way I see it anyhow.

Certainly possible, I was justing thinking “low relative to what?” - meaning lower than it should be.
Nonetheless - CPK’s comment is wrong.