Ethics in Accounting: Financial Reporting Scandals

Integrity is the most important factor to be successful in finance and business over the long term. Some people believe that the realm of finance does not have ethical considerations. But the truth is these issues are commonplace throughout all business areas.

The business climate in a lot across the globe is shaky following the revelation of numerous financial scandals that have occurred in the last few years. The optimism of the beginning of the century is now replaced with doubt and skepticism. The discussion will focus on how we got ourselves in this position and what’s being done to fix it as well as what the next chapter has in store for us. While Enron was considered the model to promote this, the breakdowns in corporate governance and accounting within Enron, as well as other corporations, will be addressed.

A few companies that have experienced problems with financial reporting will be reviewed in conjunction with the role auditing (including the role played by Andersen in Enron) and the regulatory setting, the root causes as well as the present and future possibilities for resolution.

Ethics and Accounting

Ethics (maintaining honest and truthful statements) is an essential aspect of the financial report. To be able to trust the company’s financial standing they should be confident in the company’s financial reports. Financial reporting provides all the information regarding the company’s current as well as projected health, as well as historical which means that shareholders and investors depend on the financial information that they can use to make well-informed and informed decisions. To assist companies in complying with the rules of business and keeping up-to-date financial reports, shareholders can count on the existing organizations to oversee various aspects of the accounting industry. The main institutions are Securities and Exchange Committee (SEC) The Financial Accounting Standards Board (FASB) and the Public Company Accounting Oversight Board (PCAOB). These three bodies make sure that financial reports are fair as well as reliable and accessible to all investors.

The main reason for ethics in business and the field of financial reports is that it helps guarantee the trust of investors and the public in the company. Without a clear ethical code and adherence to the code, people might not feel confident that they are investing in a safe manner. Accounting professionals should have a strong moral and ethical stance since their decisions about financial reporting can have huge consequences for individuals as companies and whole nations. Ethics in business go beyond issues related to accounting. They are because ethical standards can and do transcend the boundaries of business practices to what a business may have its accountants complete in financial reporting. Recent scandals that have involved financial reporting and accounting fraud typically started at the top of the executive team and worked their way to the financial documents.

Prior to the Sarbanes-Oxley Act, various financial frauds, like WorldCom, Enron, and Adelphia Communications plagued the American public and impacted the economic health of the entire country. The majority of these crimes stemmed from unprofessional accounting practices that were enacted at the top levels of corporations however, they were carried out through the companies that are public in their accounting practices. As of December 31, 2001, Enron was among the top energy companies in the world at one time, declared the biggest bankruptcy ever recorded in the U.S., using the retirement accounts of a large number of American employees, in order to benefit those who were at the top of the business. Utilizing thousands of off-the-records partnerships to conceal nearly $1 billion of debt and to increase profits, the company’s shareholders were cheated of billions. In the wake of these scandals, Bush and Congress were forced to take a tough stance. Bush and Congress were forced to adopt a hard-line stance by enacting the Sarbanes-Oxley Act in July of 2002.

If ethics appear to be in decline in society, every person naturally seeks out the government for help. Numerous crises throughout the history of the United States have led to the establishment of various regulators and laws. The three regulatory bodies in the US as mentioned earlier, collaborate closely to ensure the integrity of financial accounting. The SEC as well as the FASB along with the PCAOB are all independent entities, however, they frequently cooperate in certain areas, such as supervision and reporting. Although these three organizations collaborate, they depend on cooperation from member businesses and also from participation by “whistle-blowers” from companies and public figures. As the Enron collapse demonstrated that there was a systemic breakdown within the watchdog groups for private sector companies. In the end, both SEC along with the PCAOB should work in tandem and also include a way to speed-track criminal cases.

Enron as well as other scandals in reporting

Enron was an emblem of the problems that plagued corporate America since its rise was just as impressive as its demise. Enron was founded in 1985 after Internorth bought Houston Natural Gas was soon controlled by Houston Natural Gas executives, with Ken Lay as CEO. In the year 1990 the two executives, Jeffrey Skilling and Andy Fastow were brought on board. After 1996, Skilling took over as the COO and President. An explosive rise in the company’s reputation and its stock price came in the form of Enron being named one of Fortune’s”most admired corporations” in 2001, with its stock price soaring to $90.56 per share as of August 23rd in 2000. The company’s success was due to the financial genius of Fastow. But, the company’s downfall was only a matter of time With Skilling being fired in August 2001. The resignation was followed by a $1.2 billion write-off and the start of the SEC probe in November. In November, Enron announced bankruptcy, and its share price was $.26 per share.

If Enron was a single incident, concerns would have been averted quickly, and confidence in capital markets would not have plummeted. However, it wasn’t. Prior to Enron, it was possible to find firms like Waste Management and Sunbeam -they were not that significant on their own but they should have served as a warning of what was to follow. After Enron, the revelations continued to come. WorldCom was found to be capitalizing expenses. When Enron tried to outwit the capital market and accounting officials, WorldCom made accounting errors that even the most novice accountants could recognize as being unsuitable. The most troubling aspect of the scandals is that they were a result of collusion between several executives.

One important point is that the entire series of scandals cannot be blamed on only one factor. Each of them was distinct. So it is clear that the solution isn’t simple to identify. There is no one accounting procedure that has left these companies vulnerable to executive overreach.

What these scandals have to do with a common culture all-encompassing in corporate organizations. A new culture had sprung up which allowed companies to deceive shareholders as well as the market. “The goals justify the methods” became the corporate motto. The auditors, watchdogs, and the watchdogs had been oblivious to the focus being on their consulting business. They weren’t as attentive as they ought to be in audits.

Auditors’ roles in the assurance of fair play

Auditors are required to protect the public from the kinds of abuses witnessed over the years. Although financial statements are managed by management, shareholders engage auditors to ensure the security of their interests and to enhance the credibility of financial data provided by companies. For auditors to be trustworthy, they require both integrity and expertise. Expertise guarantees that if there’s an error in financial reporting that the auditor has the ability to spot the issue. Integrity guarantees that auditors will reveal any irregularity they discover. These two qualities are essential. They also have a multiplicative value that means that if one of them is absent and the other is not present, it’s useless. It was found that both were absent in a lot of cases. Audits were not conducted with the proper expertise as they were often viewed as cost-cutting policies of companies. This was usually at the expense of quality. Integrity was lost when auditors failed to remember the first loyalty of an expert in the public. Auditors rarely strayed from management in the interest of the public. So, even if they discovered reporting issues instead of bringing them to the general public, they frequently helped management to devise solutions to solve the issues.

Auditors were placed in this position (probably not due to being unprofessional or unethical, however) due to the culture of the major accounting firms. Andersen the auditor of Enron is an excellent illustration. There were auditors with good credentials who got caught in a raging economy, leading to attention to revenue generation. An audit company with the most reputable reputation for excellence and integrity sank its core values because it could be the sole way that its partners could be considered economically competitive.

In the case of the current Satyam incident in India, the fraud was uncovered by the upper management and then spread to those who had financial accounts. The role played by Pricewaterhouse the auditor for Satyam is also in question in the scandal.

The causes of problems with financial reporting

The regulatory framework had not changed overnight, and so what caused the issues with financial reporting surface in the first place, is something to reflect over. There are a variety of reasons but none that are the most prevalent.

It was the confluence of events that led to the public’s awareness of the issues. The burst of the bubble economy was the main reason why these financial abuses were brought to light. While everything seemed to be shining and clear, no one was able to question the financial statements of companies. Accounting was a topic where the absence of importance of cost accounting from the past and even the fundamental traditional accounting framework was being debated. It was clear that the “new economy” wasn’t going to last for long. In the event that it did not last investors started asking hard questions. In many of the cases, there was no answer — just denials and concealing the truth.

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In the world of auditing, audits had turned into loss-leaders. Balance accounts and the income statement were devalued therefore auditing the accounts was not necessary. So, many audits turned out to be uninformed and more of the status of a formality. There was no one willing to spend money on quality audits, which is why the majority of audit firms believed that there was no point in contesting on the basis the quality. Cost drove audit decisions. Cost reduction even when it meant less quality was the norm.

The inactivity on corporate board members was an important factor. This was exacerbated by the increasing number of complex financial transactions, many of which were not understood by the majority of board members who had gained expertise before these instruments were created. Even a former professor of accounting in charge of the Enron Audit Committee, a person with the highest integrity, was not able to grasp the significance of the financial manipulations of the company.

The biggest problem is the culture of the company. It was a focus on short-term profits, ignoring the long-term implications. The executive scorecard was focused on the amount of pay. A lot of players were overly greedy — executives lawyers, investors, and others — but what was more important was the necessity to compete on the basis the compensation.

Implications for accounting teachers

The culprits behind the majority of the financial reports scandals are former students and alumni of either accounting programs or MBA programs. Teachers must be asking themselves what they are doing wrong? What can they do to rectify the issues?

The first reaction that comes to mind is to stress ethics in accounting and business courses. This is crucial. The business ethics teachers in a course cannot dissuade anyone who has the potential to commit fraud from doing it. It is also the case that the majority of perpetrators didn’t initially intend to commit fraud. They just ended up in a dangerous zone.

Another disappointing aspect of all the scandals is the number of people who (though not directly involved) were aware of what was going on but did absolutely nothing. There are exceptions to the rule, however. some brave whistleblowers who were graduates of accounting university programs. Therefore, the goal of ethics courses should be to identify and analyze situations that may result in compromising one’s beliefs and ideas and encourage the disclosure of unacceptable behavior. This is best accomplished in context since ethics concerns are discussed in context by imagining yourself in the actual scenario. It’s simple to walk into an ethics program and provide an answer to what the teacher would like. It’s an entirely different matter to place one’s self in a scenario that has conflicting demands, and then decide what is the right course of choice when ethics are just one of the many aspects that influence your choice.

Conclusion

Accounting professionals are in a phase of change. The reputation that has been built over time and decades could be ruined within a single day. Accounting professionals were viewed as individuals of integrity who worked in a boring jobs. Today, the work is becoming more exciting but at the cost of their credibility and integrity. It is crucial to gain confidence from the general public and keep their faith in the value of accounting. The road to restoring the integrity of accountants in the present is long. It will not be quick or easy, especially with the latest series of accounting scandals that have surfaced.

References

Wikipedia online encyclopedia on Sarbanes-Oxley Act. http://en.wikipedia.org/wiki/Sarbanes- Oxley_Act#Overview_of_the_PCAOB.27s_requirements

Financial surveillance is a part of Enron: SEC and private-sector watchdogs
http://www.senate.gov/~gov_affairs/100702watchdogsreport.pdf

http://www.associatedcontent.com/article/54065/accounting_ethics.html

 

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