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Accounting for cost overruns and recoveries

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Managers must make decisions with respect to the financial reporting necessary to apply accounting standards. Consider the article "Halliburton: Accounting for Cost Overruns and Recoveries" (Tayan & McNichols, 2007). Next, using outside sources that you may seek and your professional experience, develop and write a 3 page paper concisely answering the following questions:
(A5.1) What is Halliburton management trying to achieve through decisions with respect to financial reporting for long-term projects?
(A5.2) What accounting standards must Halliburton consider when making its decisions?
(A5.3) Did Halliburton management meet its financial reporting objectives?
(A5.4) What knowledge, estimates, or assumptions did Halliburton accountants (and management) use in making decisions? Were their decisions appropriate?

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1. Halliburton management is trying to inflate its revenues and sales through decisions with respect to financial reporting for long term projects. The company policy before 1993 was to expense cost overruns as soon as they occurred but not to book claims recoveries as revenues until the repayment amount was agreed to with the client. Once the client agreed to the repayment amount, it was recognized as revenue. In 1998, there was a change in Halliburton's policies and it began to estimate future recoveries and recognized them in the same periods that the overrun expenses were realized. The effect of this policy was that Halliburton could estimate future recoveries and increase revenues/profits during the current year. It is possible that the customer may not agree to pay the money estimated by Halliburton. The claim of Judicial Watch was that over a period of four years Halliburton actually inflated the revenues by $534 million.
Halliburton had faced two adversities. First, its revenues were suffering because there was a slowdown in business. Second, the company had suffered large litigation losses from asbestos lawsuits. The lower revenues and losses from litigation would have to be reported in its financial reports and this could lead to fall in the share value of Halliburton. Further, top management ...

Solution Summary

The Halliburton Company case is explained in a structured manner in this response. The answer includes references used.

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Your firm audits Metropolitan Power Supply (MPS).

Your firm audits Metropolitan Power Supply (MPS). The issue under consideration is the treatment of the company's financial statements of $700 million in capitalized construction costs relating to Eagle Mountain, a vertically completed nuclear power plant.
Seven years ago, MPS began construction of Eagle Mountain, with an original cost estimate of $400 million and completion expected within five years. Cost overruns were enormous, and construction has been repeatedly delayed by litigation initiated by the antinuclear lobby. At present, the project is little more than 50 percent complete, and construction has been halted because MPS does not have the funds to continue.
If Eagle Mountain is ultimately completed, the state utilities commission will determine the extent to which MPS may recover its construction costs through its rate structure. The commission's rulings are difficult to predict, but it is quite possible that the commission will not allow MPS to include all of the Eagle Mountain construction costs in its "rate base." If Eagle Mountain were abandoned today, none of the construction costs would be recoverable. The related write-off would amount to over 70 percent of MPS stockholders' equity, but the company would survive.
MPS's management, however, remains committed to the completion of the Eagle Mountain facility. Management has obtained authorization from the company's stockholders to issue $500 million in bonds and additional shares of common stock to finance completion of the project. If MPS incurs this additional debt and is still not able to make Eagle Mountain fully operational, it is doubtful that the company can avoid bankruptcy. In short, management has elected to gamble?all its chips are riding on Eagle Mountain.

Discuss the arguments for and against the auditors insisting that MPS begin expensing some portion of the construction costs rather than continuing to accumulate an ever-increasing asset. Indicate the position you would take as the auditor.

Discuss whether the auditors should modify their report because of uncertainty as to whether or not MPS can remain a going concern. Indicate the type of opinion that you would issue.

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