Alternative accounting practices: earnings management using loan loss
- 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
- Earnings Management Using Loan Loss Revenues?Recent Cases
- Other researchers examining recent cases of using loan loss reserves to boost overall profit note the case of KeyCorp
- When placed in this context, it becomes evident that even though using loan loss revenues for boosting profitability is not illegal per se, it does raise a number of ethical questions about the overall actions taken by the banking organization.
- Despite the fact that there are no legal statues in place that prohibit the organization from using this tactic to boost overall profits, it would seem that the organization would have some ethical obligation to tell investors about how the organization has acquired its profits.
- Overall, the case of using loan loss reserves to boost profits is one that clearly elucidates the need for higher ethical standards in accounting.
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. [...]