Ethical and legal obligations in financial reporting have made its way into the public spot light in the United States over the last several years. The accountants who do financial reporting should be expected to act in the highest standards of legal and ethical business conduct. Unethical financial reporting can cause major problems, not only within an organization, but also for the economy. As seen in the Enron and World Com scandals unethical financial reporting affects individuals, investors, companies and the economy as a whole. (Mantzke, K., 2005) The accounting profession alone was not responsible for the scandals. I believe regulatory environment was even more responsible, with corporate governance leading the way. Both corporate charters and auditor regulation occur at the state level, allowing migration to the least restrictive venue. The SEC and the various stock exchanges tried to impose more strict guidelines, but even these were not as effective as they should be. Boards of directors, whose role is supposedly to represent the shareholders in their dealings with management, were either naïve or negligent more often naïve, in my opinion.
There are organizations who watch over accounting practices to ensure companies are providing fair and balanced account reporting. The three main organizations who watch over the financial reporting of corporate America are the Financial Accounting Standards Board (FASB), the U. S. Securities and Exchange Commission (SEC), and the Public Company Accounting Oversight Boards (PCAOB). The Financial Accounting Standards Board (FASB) is responsible for developing Generally Accepted Accounting Principles (GAAP) for the accounting profession in the United States. The FASB was created in 1971 and is the organization within the private sector which establishes standards of financial accounting and reporting. The FASB (Financial Accounting Standards Board) has declared their mission is “to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors and users of financial information” (www.fasb.org). The FASB is comprised of a seven member appointed board and approximately seventy staff members.
After the stock market crash in 1929 congress passed the Securities Act of 1933 and the Securities Exchange Act of 1933 in order to restore investor confidence in the financial market by providing some government oversight. The SEC consists of 5 commissioners appointed by the president of the United States and affirmed by the senate who serve 5 years terms. The SEC has approximately 31,000 staff members. The U. S. Securities and Exchange Commission (SEC) set the standards for financial statement disclosures for publicly held companies. The SEC was created in Organizations are expected to meet the standards set by the SEC or they will have to pay fines and penalties. The goal of the SEC is to protect investors. (Marhall, D. 2003)
The SEC website states, “The SEC requires public companies to disclose meaningful financial and other information to the public, which provides a common pool of knowledge for all investors to use to judge for themselves if a company’s securities are a good investment”. The Public Company Accounting Oversight Board (PCAOB) was created by the Sarbanes-Oxley act of 2002 and is responsible for setting the generally accepted auditing standards for public companies. The SEC appoints the board members of the PCAOB. The PCAOB oversees the auditors of public companies in order to protect the interest of investors. The PCAOB makes sure that auditors are doing their jobs and the financial statements which are released from companies are accurate. All three of these agencies work together and strive to make sure there is fair and accurate financial reporting in America.
Accounting has basic assumptions, theories and a principle that is operates by which helps with the ethical aspect. There are three main assumptions accounting operate by. First, the going concern concept refers to the assumption that an entity will continue to operate in the future. Second, is the cost principle which refers to the assumption that transactions are recorded at their original cost when recorded in dollars. Third, is the assumption that accountant use objectivity when recoding financial information. This means accountants would record a transaction the same way in all different situations.
There are also several principles which are very important in financial reporting. First is consistency. It is essential for there to be consistency in financial reporting. Financial reporting is used to compare trends and if there is no consistency in the way the data is reported the data is of no use. Second is the principle of full disclosure. This keeps any one who reads the financial statements from being mislead. The third principle is materiality. This means that exactness with the numbers in accounting is not necessary, the numbers are estimated or approximate, but they will not be misleading or wrong. The fourth principle in financial reporting in accounting is conservatism. Conservatism is when accountants make estimates that result in lower profits and assets.
Investors and managers depend on financial reports to be concise, complete, and accurate. The accountants who prepare these reports must be held to a higher standard of ethics. If accountants are using unethical ways to prepare financial documents it will be misleading to investors and cause them to invest in companies they may not have chosen to invest in if they have had accurate financial information about the company. Those who create financial documents should feel a sense of responsibility to the company and the share holder’s to uphold the highest ethical standards (Mantzke, K., Carnes, G., & Tolhurst, W., 2005). The Enron scandal is a prime example of lapse of ethics in accounting. The Enron financial documents were misleading on purpose so investors would continue to invest in the company even though the company was not doing well. When the whistle blower spoke out about what Enron had done, the business went bankrupt. Many people tried to withdraw from the investment. It was devastating to every one involved. Unethical financial reporting not only affects the company but it also affects the investors and employees of the company.
Enron was a great symbol of a widespread problem in corporate America because its rise was as spectacular as its fall. Enron was formed in 1985 when Internorth purchased Houston Natural Gas. Soon, the combined company was being run mainly by Houston Natural Gas executives, with Ken Lay as CEO. In 1990, both Jeffrey Skilling and Andy Fastow were hired and, in 1996, Skilling became President and COO. A meteoric rise in both reputation and stock value followed, with Enron named as one of Fortunes’ most admired companies in 2001 and its stock price peaking at $90.56 a share on August 23, 2000. Much of the company’s success was attributed to the financial wizardry of Fastow, now CFO. However, the company’s fall was just around the corner, with Skilling resigning in August of 2001, followed by a $1.2 billion write-off, and the start of an SEC investigation in October. By December, Enron had declared bankruptcy, Ken Lay had resigned, and the share price was $.26 per share. Today’s share price is under $.05 a share. Regardless of the causes of the financial reporting problems, the accounting and audit profession, including auditors, corporate financial officers, accounting faculty and anyone else interested in the efficient operation of our capital markets must address the shaken confidence of the public in corporate financial reports. Some steps have already been taken by regulators and the profession, but much more needs to be done.
WorldCom is just another case of failed corporate governance, accounting abuses, and outright greed. It was 1983 in a coffee shop in Hattiesburg, Mississippi that Mr. Ebbers first helped create the business concept that would become WorldCom. "Who could have thought that a small business in itty bitty Mississippi would one day rival AT&T?" asked an editorial in Jackson, Mississippi's Clarion-Ledger newspaper. Bernie's fall and the company's was abrupt. In June 1999 with WorldCom's shares trading at $64, he was a billionaire, and WorldCom was the darling of the New Economy (Marhall, D., McManus, W., 2005). By early May of 2002, Ebbers resigned his post as CEO, declaring that he was "1,000 percent convinced in my heart that this is a temporary thing." Two months later, in spite of Bernie's unflagging optimism, WorldCom declared itself the largest bankruptcy in American history. Regarding financial reporting, WorldCom used a liberal interpretation of accounting rules when preparing financial statements. And due to this liberalization in financial reporting, in July 2002, WorldCom filed for bankruptcy protection after several disclosures regarding accounting irregularities. Among them was the admission of improperly accounting for operating expenses as capital expenses in violation of generally accepted accounting practices (GAAP). WorldCom has admitted to a $9 billion adjustment for the period from 1999 thorough the first quarter of 2002.
Now the accounting profession is in the midst of a challenging time. The public used to think of accountants as persons of high integrity working at an uninteresting job. Today the job has gotten much more interesting, but at a cost of this profession’s reputation for integrity. It is essential that to win back that trust, that belief in the integrity of accountants. The road to restoring the integrity of accountants is a long one, one that will not be quick or easy.
In order for financial statements to provide useful information the accountants who prepare those statements must due so with a high ethical standard. Both the public and the business sectors must trust that the financial statements are accurate. Unethical behaviors should not be tolerated in the profession of accounting at any time. The FASB, SEC, and PCAOB are organizations within the United States which watch over the accounting policy and procedures. These organizations were created in an effort to keep accounting a highly ethical profession and so people can have trust in the financial statements in which they are provided.