The Enron Corporation: Accounting Information - Research Paper Example

The business world is heavily dependent on trusting the accounting information provided by public companies. Stakeholder groups such as lenders, investors, suppliers, and employees make decisions concerning public companies based on the assumption that their financial statements are extremely accurate and precise. Back in 2001 Enron shocked the world by declaring bankruptcy. A company that was profitable and worth over $90 a share 15 months earlier totally collapsed due to a lack of ethics, integrity, and the presence of fraudulent accounting activity. In the aftermath of this scandal the accounting profession changed forever with the arrival of the Sarbanes Oxley Act (SOX) of 2002. The accounting profession is self-regulated and its practitioners are supposed to follow the generally accepted accounting principles (GAAP). The GAAP framework was created in 1973 by the Financial Accounting Standard Board (FASB). In order for accounting to function properly the practice requires compliance of high ethical standards. Back at the beginning of the 21st century there was an avalanche of accounting scandals with the most notorious one being the Enron case. At the time investor confidence went down a lot as the credibility of the accounting profession came into question. In order to raise investor confidence the Securities and Exchange Commission (SEC) in alliance with the US congress passed a law called the Sarbanes-Oxley Act of 2002. The purpose of this paper is to describe the Enron case and to provide a detail analysis of the different aspects included in the Sarbanes and Oxley Act of 2002. The Enron Corporation is one of the worst cases of corporate corruption America has ever seen. The situation was very odd due to the fact that Enron Corporation was regarded as one of most respected companies in the energy industry in the late 1990’s and at the beginning of the 21st century. Between 1995 and 2001 Enron received for six consecutive years the award of most innovative company given by Fortune Magazine (Bbc). There were no warning signs that the company was facing any financial troubles as every year they would come up clean in the annual audit performed by the accounting firm Author Anderson. The company was founded in 1985 and before its collapse the firm was the 7th largest company in the United States with over 21,000 employees on payroll including an international operation that spread across 40 countries (Bbc). On December 2, 2001 Enron Corporation file for bankruptcy which at the time was the biggest bankruptcy in the United States history. The demise of Enron occurred due to a lack of corporate ethics. The unethical behavior started at the executive management level and spread throughout the organization like a virus. An example of how unethical the employees had become is the actions of the energy traders. The traders would intentionally shutdown power grids leaving entire towns without energy with the sole purpose of driving the price of energy up once the energy was turned back on. A lack of ethics and corruption was more evident at the executive management corporate level. The managers of the company were cooking up the accounting numbers of the firm. The corrupt managers colluded with its auditor, Author Anderson, so that they would look the other way and not revealed the fact the accounting numbers did not add up. A technique the firm used to hide losses and its debt was designing a complex web of partnership which used off-balance sheet accounting to alter reality. The firm completely mismanaged the pension fund of the employees. Instead of saving the pension money and using a sound diversification strategy the managers decided to use the pension fund to finance the firm’s illicit activities. The fund was depleted and invested solely in Enron common stocks. The managers of Enron prior to the full scandal being revealed decided to sell all their shares of Enron stocks at full market value; a few months later the Enron stocks became junk penny stocks. Insider trading is an illicit act forbidden by the Securities and Exchange Commission. Insider trading occurs when a person makes investment decisions based on privileged information (Teweles & Bradley & Teweles). The United States investor community was in panic mode after the Enron case. Other huge scandals followed Enron including the WorldCom bankruptcy which exceeded Enron as the biggest bankruptcy in United States history. The credibility of accounting numbers began to come into question by the investor community. The situation was sad since the majority of public firms were running legit operations that used sound accounting principles free of bias and fraudulent activity. The SEC and the US Congress decided to take proactive actions to deal with the problem and as a consequence they created the Sarbanes & Oxley Act of 2002. The Sarbanes Oxley Act changed the accounting profession by improving internal controls, fraud prevention, accountability, auditing standards, and it established criminal penalties for executives involved in fraudulent accounting activity. The Enron scandal left a very bad feeling in the minds of investors. There was a perception among investors that auditing firms had become advocate for their clients rather than independent judges of the reliability and accuracy of financial statements (Bather & Burnaby). A solution that was included in the Sarbanes-Oxley Act to deal with the issues associated with conflict of interest in auditing relationships was creating the Public Company Accounting Oversight Board (PCAOB). “The PCAOB was created to oversee the auditors of public companies in order to protect the interests of investors and further the public interest in the preparation of informative, fair, and independent audit reports” (Sox-online). Due to SOX it is mandatory for all accounting firms that which to perform audits on public firms to register with the PCAOB. Conflicts of interest among auditors were a common occurrence before the creation of the Sarbanes-Oxley Act. Firms that audited companies also performed other accounting work for the same company including cost accounting, payroll, financial accounting, and consulting work. Since the firm wanted to retain the client at all cost the possibility of biased accounting audits existed. The creation of the PCAOB was one of many measures that SOX implemented to prevent conflict of interest problems and to raise the accountability and credibility of auditing work. Ever since SOX the auditing work performed by auditors in public corporations is referred to as the independent auditor report. Auditor independence is covered in Title II of the Sarbanes-Oxley Act. Section 201 of the Act imposes restrictions on auditors to restrict their ability to perform non-audit services on the public firm they are auditing. Some of the non-audit services restricted by SOX include: bookkeeping, financial information design, appraisals, actuary services, internal audit services, management functions or human resources, investment advice, or legal services (Findlaw). Section 203 of the Act establishes the requirement for audit partner rotation. According to section 203 it is illegal for an accounting firm to send the same auditing partner to perform an audit on a public firm for more than 4 consecutive years. Section 204 of SOX requires auditing firms to report their findings to an audit committee. Section 206 of Sarbanes-Oxley deals directly with conflict of interest by making it illegal for an accounting firm to perform an audit on a public company that has a chief executive, comptroller, chief financial officer, chief accounting officer, or an employee in a similar position of responsibility that had previously worked for the accounting firm (Findlaw). The Sarbanes-Oxley Act raised the accountability and responsibility of corporate officers in regards to the accounting information released by companies on a quarterly and annual basis. It is now mandatory for the CEO of the firm to sign the quarterly and annual financial statements publish by their company. The signing of the financial statements means that these officers are guaranteeing that the statements are free of error, corruption, and fraudulent activity. Section 802 of the Sarbanes Oxley Act established criminal penalties for corporate officers involved in fraudulent activity. A person found guilty of altering, destroying, mutilating, concealing, or falsifying records of public company can get receive up to 20 years in prison. Also any accountant involved in the auditing reviewing process that covers up a fraud can receive up to 10 years in prison for their crime. Section 404 of SOX establishes the requirement of adding an internal control report within the annual report of the company. One of the issues with the internal control requirements of SOX is that the costs of implementation are disproportionally high for medium size firms in comparison with large firms (GAO). The Sarbanes Oxley Act has been a very effective tool at preventing fraudulent activity in the United States among public companies. The first line of defense for investors to detect fraud is the auditors. The case of Enron would have never occurred if SOX had existed back then. Author Anderson got away with collusion in the Enron case and in the aftermath of the scandal the company was investigated and it was revealed that their unethical behavior was a recurrent pattern. Title II of the Sarbanes Oxley Act included lots of bylaws that created auditor independence in the profession. Another way that Sarbanes Oxley has helped stop fraudulent activity was by redefining white collar crime punishment. In the past CEOs and fraudulent accountants did take the penalties for white collar crimes serious as jail time was not given or very short sentences and the fines were low. Sarbanes Oxley changed that corrupt culture as it raised the bar and imposed maximum penalties of 20 years in prison. “Management accountants should maintain and unwavering commitment to ethical value” (Garrison & Noreen & Brewer, pg. 1). The financial marketplace which includes the stock market is very important for the functionality of the corporate world. Public corporations are highly dependent on the sale of stocks to finance its activities. It was imperative for the government to intervene back in the early part of the 21st century in order to ensure the integrity of the markets. The Sarbanes-Oxley Act of 2002 was the perfect solution because it created new standards that accountants had to follow to increase the accountability and reliability of accounting information. The trust that SOX created in the system has ensured the stock market maintained its liquidity. Sarbanes Oxley is great, but its implementation has come at a steep cost for public corporations. The average cost of implementing Sarbanes Oxley for businesses is $4.36 million a year (Gingrich & Kralik). Despite the high costs the benefits that SOX brought to the accounting world increased the trustworthiness of accounting information. Work Cited Page Bather, A., Burbany, P. “The Public Company Accounting Oversight Board: national and international implications.” Managerial Accounting Journal 21.6 (2006). 657-669. Bbc.co. 5 July 2006. “Q&A: The Enron case.” 7 August 2011. < http://news.bbc.co.uk/2/hi/business/3398913.stm> Findlaw.com. 2002. “H.R. 3763.” 7 August 2011. < http://fl1.findlaw.com/news.findlaw.com/cnn/docs/gwbush/sarbanesoxley072302.pdf> Garrison, R., Noreen, E., Brewer, P. (2010). Managerial Accounting (13th ed.). New York: McGraw-Hill Irwin. GAO. April 2006. “Consideration of Key Principles Needed in Addressing Implementation for Smaller Public Companies” GAO-06-361. Gingrich, N., Kralik, D. 5 November 2008. “Repeal Sarbanes Oxley.” 7 August 2011. Teweles, R., Bradley, E., Teweles, T. 1992. The Stock Market (6th ed.). New York: John Wiiley & Sons. Sox-online.com. 2006. “The Public Company Accounting Oversight Board (PCAOB).” 7 August 2011. Read More