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The past decade was defined by significant accounting scandals which to a greater extent, were argued to have contributed to the recent economic depression. However, through studies and analyses, all have been attributed to poor corporate governance, lack proper or poor auditing oversight as well as the failure of the regulatory body to lay appropriate and binding standards that could have identified the loopholes to unethical accounting practices. Therefore, the subsequent analysis on Enron, Madoff, Lehman and WorldCom scandals determine how the above reasons contributed to the scandals and what lessons can executives, businesses, auditors and regulatory bodies learn to redress the problems in future.
Role of auditing
Efficient accounting compels the need for internal and external checks as the roles of the auditors and as well as the relevant accounting regulations (Gillis et al., 2014). Accordingly, the purpose of the accounting regulations is for safeguarding companies against the serious financial frauds (Hribar et al., 2014). A sound regulatory framework is essential in protecting businesses from imminent financial risks as they define the ethical standards obliging accountants and auditors to uphold a higher degree of professionalism (Gillis et al., 2014).
The Enron fraud happened because auditors and regulatory bodies did not ensure proper assessment to ascertain continuous auditing in the form. Therefore, lack of continuous auditing at Enron meant that the wrong treatment of Special Purpose Enterprises (SPEs) would not be identified (Peavler, 2017). Accordingly, continuous auditing is meant for controlling and monitoring, on a constant basis, all the transactions within the organization (Hribar et al., 2014). In the Enron’s case, the internal and external auditors aided and liaised with the executive management in hiding some of the financial statements from the stockholders and made the company appear to be a healthy financial situation or condition which was not the case. The auditors and the accountants, upon realizing the financial situation of the company had created SPEs for accounting purposes but were not real assets within the company.
The role of Regulator
Enron’s case embodied the negative and improper adherence to the accounting regulations. For instance, despite the accountants designing their financial transactions in line with the law, they failed to report on the financial health of the company accurately. For example, the SEC obligations were followed in reporting but the accurate profit status of the corporation not reported. During the scandal, the Financial Accounting Board (FASB) noted with a lot of concern the lack of oversight that safeguards the special purpose entities/enterprises (Peavler, 2017). In Enron’s case, the Security and Exchange has the mandate of such a role, by establishing the acceptable accounting and auditing standards. Lack of a proper regulatory oversight by then was responsible for the fraud since it was due to the scandal that the Sarbanes Act was enacted to ensure ethical and transparency in financial reporting and accounting management.
According to Security Exchange Committee, there are regulations compelling accounting disclosure of transactions exceeding $60, 000 when the executive officials in a corporation have vested stakes (Kim and Laffitte, E., 2002). Such disclosure includes the name of the individual, relationship to the registrant, the transaction value in addition to overall interest that the individual has as regards to the overall transaction. However, these were overlooked by the auditors and accountants at Enron, for instance, the 2000-2001 financial statement documented that Fastow, as the Vice President, was poised to get a specific amount subject to the overall performance of the partnership (Peavler, 2017). Conversely, the value or amount which Fastow was entitled or received was not disclosed, and as such, through auditing, it was reported that the values had been manipulated on the financial or income statement for the basis of protecting Fastow.
Enron’s case was due to the failure of the executive management especially when it opted for the fair-value accounting practices. Besides, the management failed to accurately report and documents the stocks they issued and treated or held under the SPEs (Peavler, 2017). From this, the executive management promoted an environment or management approach that embraced inadequate disclosure of all the transactions, hiding costs as well as conflict interests. Enron’s case was weak financial reporting, accountability to the stockholders and falsifying assets held, more so for the SPEs.
WorldCom also ranks among the major scandals to ever have rocked the corporate world, especially with the misclassification of the assets and as such, putting the company or corporation in a situation of overstated earnings, with $3.8 overvalued in terms of income (Tran, 2002). In this case, the networks of other companies had been classified as the expenditure of the firm.
WorldCom’s case also presented the same case of auditing. For instance, there was knowledge of the misclassification of the assets. The auditors, in this case, were found guilty as they knew about the misclassifications by the top management or officials and refused or declined to report (Tran, 2002). However, the case shows how an internal auditor played a role in raising the alarm about the on-going fraud in the company as Cynthia Cooper, realized that the line costs were being treated under the capital expenses (Miss, 2002). KPMG was contracted as the external auditor to view the case. The internal auditing within the firm could have known what was going on in the company reported the misclassifications. Nonetheless, WorldCom’s case highlights the role of external auditor (Anderson) in promoting fraud. Anderson had lied about not receiving information about the misclassification that occurred with the line costs and being treated as the capital expenditure of the firm; he was the in charge of the auditing activities in the company. The role of auditing, in this case, should be on advising the company about its financial health and direction (Hribar et al., 2014). Anderson’s unethical auditing shows how auditing also contributed to the scandal. On the other hand, Cooper as an internal auditor, having brought the issue on-board, also highlights how internal auditing can also function as a buffer against financial or accounting frauds.
Conversely, one of the significant roles of corporate governance is on financial reporting, which should be upheld through honesty and integrity (Leventis et al., 2013). In the WorldCom’s case, the executive management engaged in the misclassifications to cover their tricks. For instance, the misclassification had been as early as 2000, with e-mail communications and documents showing how Anderson (the mastermind) knew about everything that had been going on in the company (Miss, 2002). Corporate governance recommends and advocates sound behaviour among executives, but there were elements of the executive management using their positions for personal gains, for instance, the protection of weak financial conditions. Investigations later revealed that Chief Executive, Ebbers, had been going through financial difficulties hence the fraud was for maintaining personal financial situation (Tran, 2002). The chairman had also used his position to secure loans through his stock, majorly focused on financing his businesses. To continue using his position for financial gains, the CEO would encourage the falsification of the financial statements of the firm, and as such, made it appear that the company was recording a continuous growth and the net worth was surging. Corporate governance advises against the executives using their role or position for personal gains or interests and that they should act as the checks and balances in preventing or detecting financial irregularities (Leventis et al., 2013). Besides, there is the principle recommending the necessity for accurate financial reporting, transparency in financial dealings and presenting the real accounts of what transpires in the organization (Agrawal and Cooper, 2017).
A Later review by the new management revealed that the fraud was attributed to the pressure piled on the executive officials. Poor corporate governance was defined by the CEO presenting false reports to SEC. Besides, the rot spread from the executive management to the lower hierarchy since the employees knew about the email communications; they were aware of the fraud but hid the crime. Corporate governance is equally defined and led by ethics. In the case, there was a lag from the executive management, for instance, a proposal was made on introducing a code of ethics, but the CEO cited the recommendation as a waste of time (Tran, 2002).
The role of Regulatory Bodies
SEC and FASB, to some extent, could be blamed for the fraud because given the timespan that it had occurred, almost five years, the bodies would have carried out early and prompt investigations. However, SEC moved in when the company had filed for bankruptcy by requesting court order stopping the form from destroying its financial records.
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The Lehman Brothers
The Lehman Brother’s case majorly highlights the corporate governance with fraudulent accounting practices used by the firm. The case is another situation or scenario of inaccurate accounting reporting, whereby the individuals were accused of using accounting gimmick so that it would make the company appear as if off-loading risky assets and reducing the balance sheet. The practice would be known as Repo 105 of which for every repo transaction, cash would be raised by selling assets the promising to buy them back, or other words, short-term financing (Merced and Sorkin, 2010); such transaction would remain as a financing and not a sale, thereby leading to the assets remaining on the firm’s balance sheet. However, Lehman regarded the transactions as genuine sales under repo 105, and as such, the risky assets were taken off the books. In this case, the corporate governance issue was the failure to disclose the transactions. On the other hand, the ethical concern was on the false reporting on the financial status of the company.
The Lehman’s case is also considered as taking advantage of the loopholes within the accounting standard language on repurchase agreements (Merced and Sorkin, 2010). It was unethical for not recording liabilities of the asset transactions and taking them off the balance sheet, of which the cash received would be used in repaying other debts to lower the leverage. The case highlighted some of the loopholes in the regulator, especially on the unspecified or defined accounting standard language. On the other hand, an excellent lesson could be learned as concerning how auditors, executives, and regulators on treating repos and financial reporting.
The Madoff scandal highlighted the role of corporate governance and auditor in accounting frauds. All the major accounting firms including PricewaterhouseCoopers, KPMG, and BDO were accused of their lack of detailed oversight on the feeder funders (Gandel, 2008). Hence, the big auditors did not assess and evaluated on the financial performance of the feeder funders to Madoff. Nonetheless, Madoff relied on Friehling & Horowitz as the auditor, which further raised question owing to the small size of the firm, with only three employees. Most of the firms audited by the major auditing firms had confirmed to have been cleared as financially “healthy” of which all the regulatory and accounting or security standards were followed. Hence, for this case, it shows the role and necessity of detailed auditing and how auditors have a role to play in presenting accurate information and digging deep into understanding the financial positions of their clients.
The transactions by Madoff also highlighted his shortcomings in corporate governance and ethics. He had created false statements, distributed them to clients and as such, claimed that the transactions were generated from the funds injected into the firm (Gandel, 2008). In this regard, it highlighted unethical accounting practice and misrepresentation of accounting information.
In summary, few lessons could be learned from the significant scandals. For one, corporate governance in accounting and financial management calls for integrity, transparency and strict adherence to the regulating standards. Reporting of the financial status of the company should be accurate, whether losses are being made or not because misrepresentation can lead to legal action from the relevant bodies. Another concern is ethics safeguarding corporate governance, especially on accountability and honesty as well as desisting from fraudulent accounting practices. As such, auditing should be a continuous report and care should be taken that proper and detailed auditing is ensured to allow the management the chance of understanding the direction of its financial direction. Hence, accounting frauds are best addressed through corporate governance, transparency in auditing and ethical conduct among the executives, accountants, and auditors.
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