Accounting statements rarely report financial performance without error. List three types of errors that can arise in financial reporting

Answer 1

Three types of potential errors in financial reporting include:
1 . error introduced by rigidity in accounting rules;
2 . random forecast errors; and
3 . systematic reporting choices made by corporate managers to achieve specific objectives.
Accounting Rules. Uniform accounting standards may introduce errors because they restrict management discretion of accounting choice, limiting the opportunity for managers' superior knowledge to be represented through accounting choice. For example, SFAS No. 2 requires firms to expense all research and development expenditures when they are occurred. Note that some research expenditures have future economic value (thus, to be capitalized) while others do not (thus, to be expensed). SFAS No. 2 does not allow managers, who know the firm better than outsiders, to distinguish between the two types of expenditures. Uniform accounting rules may restrict managers' discretion, forgo the opportunity to portray the economic reality of firm better and, thus, result in errors.
Forecast Errors. Random forecast errors may arise because managers cannot predict future consequences of current transactions perfectly. For example, when a firm sells products on credit, managers make an estimate of the proportion of receivables that will not be collected (allowance for doubtful accounts). Because managers do not have perfect foresight, actual defaults are likely to be different from estimated customer defaults, leading to a forecast error.
Managers' Accounting Choices. Managers may introduce errors into financial reporting through their own accounting decisions. Managers have many incentives to exercise their accounting discretion to achieve certain objectives, leading to systematic influences on their firms' reporting. For example, many top managers receive bonus compensation if they exceed certain prespecified profit targets. This provides motivation for managers to choose accounting policies and estimates to maximize their expected compensation.