BS, IS, CF may be recast with standardized line-item descriptions and

classifications
Recasting financial statements into a template that uses
standard terminology and classifications Firms vary in formats used to report financial results (e.g., nature vs
function)

Lease, Who control the assets? Lessor or Lesse?

Mechanical rules may not capture economic ownership

Some types of transactions make it difficult to assess who owns the
The firm owns/controls the economic resource
asset
Or may induce managers to structure transactions to achieve an
accounting outcome rather than reflect the economics of the
transaction

Benefits are hard to estimate, IFRS requires immediate expensing of

such as research expenditures
some expenditures that may have future economic benefits,
Future economic benefits can be measured with reasonable certainty
Judgment is required to assess the realisability of recorded assets, and the amount recorded,
impairment amount, depreciation, useful life, may be misstated

Fair values of assets Fair values of assets fall below their book values Technology impact

Delay in writing down assets when expected benefits have declined

Asset Distortions Distortions may generally arise from ambiguities about whether
Underestimate provisions such as the provision for bad debts
Overstated, Overstating assets can boost net assets,equity, and
Accelerate recognition of revenues by recognising revenue and
earnings
accounts receivable before revenue is earned

Underestimate rate of depreciation, overestimate useful life,

overestimate residual value
How assets might be misstated
Overstate write-down of assets

Overestimate provisions

Understated, Understating assets can reduce net assets, equity, or Overstate depreciation
earnings, but may boost ROE
Do not record intangible assets

Structure leases as operating leases that are off balance sheet

financing

An obligation has been incurred Joint Operation?

The measurement of an obligation warranty?

Incentives to overstate earnings

Understated liabilities may arise from: Incentives to understate the amount of debt

Difficulties in estimating the amount of future financial commitments

Liability Distorsions Distortions may arise from ambiguities about whether:
Record unearned revenue as revenue

Remove accounts receivables from balance sheet when they have

been sold with recourse (meaning the company will have to guarantee
some funds if the customer fails to pay)
How liabilities are misstated
Leases structured as operating leases rather than financial lease so
the asset/liability are off balance sheet

Pension liabilities understated

Distortions in assets and/or liabilities can distort equity

Equity Distortions
Effect of hybrid securities Convertible Bonds