Oak Industries, Inc. Case – sample answer

1. Is it unethical for a company to intentionally understate its earnings? Why or why not?

Yes, it is clearly unethical to intentionally understate earnings since the management makes representations that the financial statements are complete and accurate. It is obvious that intentionally understating earnings is done to allow the company to later overstate earnings by using falsified reserves to cover the inadequate current period earnings. These manipulations and misrepresentations do not allow fair comparisons of the results of operations between years. In this case the misrepresentation gave a totally false picture of the success of its subscription television systems and interfered with the ability of users to correctly analyze the financial information of the firm. These misrepresentations impaired the decision-making ability of the financial statement users and defeated the purpose of financial statements presenting a true and accurate picture of the company. 2. Should auditors be equally concerned with potential understatements and potential overstatements of a client’s revenues and expenses? Identify audit techniques that may be particularly helpful in uncovering understatements of revenues and overstatements of expenses.

Auditors are required to plan and perform an audit to obtain reasonable assurance that the client’s financial statements are free of material misstatements. These misstatements include overstatements and understatements of both revenues and expenses, and auditors should be concerned with each of these items. However, since company executives are much more likely to overstate revenues and understate expenses, auditors are more focused on the possibility of revenues being overstated. Auditors are taught to be conservative and are naturally biased in that