Accounting Ethics Breach - Research Paper Example

Accounting Ethics Breach: Case Study Accounting Ethics Breach: Case Study The recent decade witnessed a series of corporate scandals and bank failures as a result of poor corporate governance practices. The failures of corporate giants like Enron and WorldCom greatly insisted the corporate world to review the existing corporate governance principles and improve the transparency of corporate transactions. Hence, the current business and regulatory environment is more conducive to ethical behaviour than that of the past. In response to the recent accounting scandals such as Enron, Tyco International, Adelphia, Peregrine Systems, and WorldCom in the United States, the Federal government has enacted a law called Sarbanes-Oxley Act 2002. This act includes provisions for stricter financial governance laws which would make managers and other executives accountable for their operations. Similarly, the United Kingdom has passed the UK Corporate Governance Code 2010 in order to regulate the operations of companies listed on the London Stock Exchange (Murphy & May, 2012). The Code comprises a set of good corporate governance principles. In addition, the Financial Conduct Authority’s Listing Rules require public companies to disclose how they comply with the Code. These strict operational policies would act as a moral check on top executives as well as managers, and therefore they are not very likely to involve in fraudulent business practices. Increasing number of employee cuts since 2009 has also persuaded employees to be ethical in their activities. Finally, technological advancement has also played a significant role in making the current business and regulatory environment highly conducive to ethical behaviour. Enron Scandal The Enron scandal was revealed in October 2001, and it resulted in the bankruptcy of Enron Corporation, an energy company based in Huston, Texas, United States. Enron failure became the largest bankruptcy reorganization in the US history at that time, and it was the biggest audit failure. The merging of Huston Natural Gas and InterNorth led to the formation of Enron in 1985. Several years later the company hired Jeffrey Skilling as the president and COO of Enron, and he created special purpose entities through the use of accounting loopholes to hide huge amount of debts from failed projects. Skilling, with the help of Chief Financial Officer Andrew Fastow and other executives misled the firm’s board of directors and audit committee, and continued to follow high risk accounting practices. They also compelled other top official to ignore the issues identified. Although Skilling and his colleagues could hide the actual debt status of the company for a few a years, shareholders and other stakeholders detected the fraud when the company’s stock price plummeted from US$90.75 per share in mid-2000 to less than $1 by the end of 2001 (Wn.com., n.d.).The company shareholders filed a $40 billion lawsuit against Enron. Subsequently the US Securities and Exchange Commission (SEC) declared an investigation. Although Enron’s competitor Dynegy had offered to take over the company at a cheap price, the deal failed. As a result, Enron filed for bankruptcy protection under the Chapter 11 of the United States Bankruptcy Code. Detection and Pitfalls First industry analysts and economists questioned the doubtful transactions of Enron. A Fortune article titled ‘Is Enron Overpriced?’ raised many doubts concerning the high stock values of the company. The article claimed that Enron investors actually did not know how the company was maintaining its high stock prices. Although many other analysts also pointed out improper accounting practices in the company, Skilling and Fastow strongly opposed those reports. Skilling often verbally attacked individuals who pointed out issues with Enron’s accounting practices. However, those industry analysis reports questioning the high stock prices of Enron made company shareholders doubtful about Enron’s profitability. In addition, the firm’s profit margin stayed at modest average and share priced began to decline in spite of doubling revenues. Serious concerns were raised when the company suffered huge losses from developing the Dabhol Power project in India. That company was criticized for the role that its subsidiary Enron Energy Services played in the California electricity crisis of 2000-2001 (The Wall Street Journal, 2003). By the end of late 2001, company’s share prices began to drop drastically, and it really lead to the detection of Enron accounting fraud. While analysing the Enron case, it is obvious that the company failed to create an ethical environment. The firm’s performance management system significantly contributed to an unethical corporate culture which in turn resulted in excessive executive compensation and large expense accounts. Similarly, poor risk management practices and absence of a potential financial audit system played a notable role in leading the company to bankruptcy. In short, Enron scandal was the result of weak corporate governance practices. Violation of Accounting Guidelines Skilling adopted mark-to-market accounting approach to record its accounting transactions related to long-term contracts. Since it was a complex concept to understand, Skilling could easily mislead Enron investors and use large discrepancies to match profits and cash. Under this approach, it is possible to record income from projects even though the company would not ever receive the money. This provision greatly assisted Skilling and his colleagues to increase financial on account books and thereby inflate profits on yearly reports. In July 2000, Enron signed a contract with Blockbuster Video to introduce on-demand entertainment services in the United States. Enron recorded estimated profits of over $110 million from this project despite analysts’ concerns regarding the technical feasibility and market acceptance of the service. Blockbuster Video withdrew from the deal when they identified errors in the network, but Enron continued to record future profits even though the deal actually ended up in loss. Such accounting irregularities assisted the company to post constant increases in revenues and meet stakeholder satisfaction. The organisation had practiced ‘the snowball’, an accounting method where costs of cancelled projects were recorded as assets. Enron intentionally altered the provisions of this approach to publish financial reports in its favour. However, such fraudulent accounting practices benefited the company officials to gain stakeholder confidence. According to an opinion, “the most important lesson from the Enron collapse is both the centrality and fragility of organisational trust.” (Currall & Epstein, 2003). Recommendations Enron could have avoided complex and doubtful accounting practices like mark-to-market accounting, which played a notable role in ballooning the revenues of the company. A well structured risk assessment system would assist the company to timely detect risky accounting practices and ensure fairness and reliability in the preparation of final accounts. Similarly, each and every transaction should be justified by supporting vouchers and invoices because this system is beneficial to promote accuracy of accounting. Furthermore, no money should be recognised as revenues before it is actually received by the company. It is also advisable to appoint whistleblowers as this strategy can benefit the organisation to detect and prevent errors or fraud on time. Finally, the company must have a strong auditing and internal check system in practice to discourage accounting malpractices and financial fraud. References Currall, S. C & Epstein, M. J. (2003). The fragility of organizational trust: Lessons from the rise and fall of Enron, Organizational Dynamics, 32 (2):193-206. Murphy, P. C. F & May, S. (Eds.). (2012). Corporate Governance for Main Market and AIM companies. London Stock Exchange plc. Retrieved from http://www.londonstockexchange.com/companies-and-advisors/aim/publications/documents/corpgov.pdf The Wall Street Journal. (March 20, 2003). A Chronology of Enrons Woes. Retrieved from http://online.wsj.com/news/articles/SB1017425100546270840 Wn.com. The Biggest Risk To Shareholder Value. Retrieved from http://article.wn.com/view/2013/12/13/The_Biggest_Risk_to_Shareholder_Value/ Read More