Normally, the business judgments rule requires the management of an enterprise must act in the best interest of its company. It means the management must implement their fiduciary duties, such as faith, integrity and duty or care. In other words, the management has a duty to maximize the value of their enterprise. If their behavior observes their duty and company's interest, it protects the management from their decision-making even if there is a loss or bad result. It is clear that the business judgments focus on the interest of shareholders and it emphasize lawful and reasonable behavior of the management of an enterprise.
However, because of different natures between above two judgments view, it may cause conflict on financial statement of an accounting entity.
As to the mention above, under the different base of view, management and auditors intend to use different accounting method to deal with an accounting entity's business activities. It can be reflected following aspects.
The first example is depreciation method. In order to reduce the fixed expense, management often intends to use slight accounting method to calculate depreciation. For example, they prefer straight line method and longer booking period, which will make more book value of fixed asset and more profit. In this situation, auditor must check the depreciation method to make sure the asset's book value equal its market value.
The second example is accrual accounting method. In most business environments, accrual accounting system can make the financial statement fairer and accurater. Some directors, especially the listed companies, always intend to make beautiful profit figure to ensure the share price increase in stock market. In such circumstances, some pre-sell may be booked as current revenue. At accrual accounting view, these incomes must be recognized as future revenue even the payment has already received. Auditors should check the timing and make sure the business activities match the accounting period.
The third example is provision of doubtful debt. Reviewing some famous accounting fraud cases, such as MCI Worldcom, the management often uses these provision accounts as the “profit pool". By increasing or decreasing the account balance of provision of doubtful debt and other similar accounts, net profit can be enlarged or shrinked, which will causes misstatement of final financial statement. Here, independent auditors need use their professional judgment to minimize the risk of misstatement. It means auditors take more rigorous test and more compliant accounting standards to recognize the book value.
The fourth example is regarding to recognition of assets, especially intangible assets. In order to modify profit figures, some directors intend to choose most favorable accounting method when they...