Roles of Accounting in Banking Scandals - Essay Example

The Roles of Accounting in Recent Banking Scandals Accounting involves the “the process of identifying, measuring and communicating financial information about an entity to permit informed judgments and decisions by users of information” (University of Leicester, 2009. p. 6). It aims at providing information about the financial status, performance and flexibility of an enterprise to various users of such information for evaluating the competence of management and for economic decision making (University of Leicester, 2009). The capital providers are the main users of financial information thus the financial report should convey details about the economic resources of the entity, claims attached to the resources, all transactions and any other event or circumstances that may alter that information. The usefulness of the financial report depends on its qualitative features (Young, 2006). The study examines the roles of accounting in the recent banking scandals using case studies of JPMorgan and insider trading involving Nomura Group in Japan. According to Young (2006), accountants have the responsibility to prepare financial statement for use by other stakeholders in making economic decisions. The roles of accountants involve data collection, recording, ensuring accuracy, analyzing and presenting financial statement to the stakeholders whenever it is required. The principal objective of financial accounting is to deliver pertinent financial information to users of that information such as creditors, business managers, government, employees, consumers, suppliers, investors, financial analysts, etc. for effective decision making (Saravanamuthua & Tinker, 2003). However, the dissemination of accounting information should be done to the relevant stakeholders and those concerned must avoid sharing information with unintended users as was in the case study of Nomura Group discussed below (Ezzamel et al., 2004). Due to the complexity of businesses the accounting standards require uniformity in a preparation of financial statement in order to promote comparability of financial statements across the firms operating in the same industry (Young, 2006). This implies that accountants should follow the standard procedure of preparing, recording, analyzing and presenting financial statements (Young, 2006). The need for uniformity of accounting information was also necessitated by complexity of a business environment requiring multiple accounting approaches such as mergers, acquisitions, sales-leasebacks, consolidations, research, goodwill, etc. (Young, 2006). Before making strategic decision such as the business acquisition accountants should conduct thorough investigation the business asset and advise the managers appropriately on whether the deal will be successful after carrying out in-depth analysis of cost and benefits (Roberts, 1991). Therefore, accounting practices are goal-driven hence accountants work in pursuance of particular goals and their roles cannot be considered as the end but means to achieve the specific target. According to Armstrong (2002) accounting involves construction and communication of reality. However, when the accounting practices divert from the objective of fact, it turns into a mere social construction presenting human understanding and gain social acceptance (Bryer, 2006). For example, activity-based cost management techniques have been constructed to satisfy the Anglo-Saxon capitalism market that has operated under the intense institutional force from labor market, consultancy and management education that has resulted in “distinction between expert and management power“(Armstrong, 2002, P. 286). This process has resulted in a development of an overview management concept discrete from expertise in the accounting practices that can characteristically be fitted in all processes. In all managerial hierarchies of British capitalism, accountants are highly represented compared to other professionals (Armstrong, 2002). The implication of such representation is based on the notion that such representation gives the business its technical understanding that increases competitive advantage of that business (Davie, 2000). Accountants have a significant role to play when it comes to product design and pricing techniques. During the production process, the products undergo various stages and at each stage of production the product incurs some cost directly or indirectly (Armstrong, 2002, p. 286). While the traditional approach of determining the production cost of the products based on the total units produced and the total cost incurred, this approach did not project the actual cost hence the profitability of the products was just an approximation (Armstrong, 2002). Since the information concerning business profitability is essential to the users of that information lack of fair projection of business profitability is misleading and unreliable. However, the modern accounting techniques projects more reliable information about the cost and profitability of the business (Armstrong, 2002). For example, accountants are using activity-based cost management to fix the cost of the product at various stages of production. The method has contributed to a more accurate projection of cost and profitability of the products (Armstrong, 2002). Furthermore, it has helped businesses to manage cost by focusing on stages with the high cost and make suggestions on how to minimize that cost. Also, accountants provide guidance on how to maintain low cost in order to increase market share of the firm. The use of accurate and reliable financial information has helped businesses to remain competent in the market because they can control the market expansion and superior products that make the business stay far ahead of its competitors (Armstrong, 2002). Accounting practices involves accountability, representation and control of financial information regarding the organization and ensure it is relevant for decision-making (Barnes, 2014). Accountability involves means by which individuals and firms are held to account for their conducts. It empowers some individuals to demand others to account for their conducts. In this regard, accounting process must include a procedure for sharing the set of principles of expected ideal behavior of what is acceptable or unacceptable (Barnes, 2014). Accountability in the auditing system ensures the organization’s management is held liable to the source of capital. Accounting-led organizations provide adequate space for calculative individuals’ responsibility and distribute the powers to the individuals in more energetic stretchy control structure that enables them to restrain themselves in a relentless show of accountability and responsibility (Hines, 1988). In the modern society ethical principles, require all employees to discern right from wrong and ensure they carry out their businesses in morally acceptable ways (Hoskin & Macve, 1988). For example, accountants should avoid disclosing information in a manner that will give some people advantage over others. One of the ways in which institutions are exercising accountability is by the use of standard costing as a strategy for controlling cost of products and business operations (Hoskin & Macve, 1988). The goal of standard costing is to establish future planning on cost for measuring performance. It enables firms to predetermine the cost of production against which the actual cost is compared to determine what each product should cost under prevailing conditions. Standard costing assist organizations to evaluate its performance, conduct stock valuation, control stock and establish selling price of its products (Arnold, 2009). The standard costing process serves various purposes. First, it enables organizations to set standards for each operation, compare the actual performance with the set standards, explore and report the variances occurring between actual and expected performance, and examining the substantial inconsistencies and taking appropriate action to correct the variances (Lehman, 2005). Standard costing is guided by two principles. First, the set standard is at the beginning of a period is the appropriate measure for the entire duration. Secondly, the outcome is adequate if it satisfies the set standards (Lehman, 2005). According to the University of Leicester (2009), accountants have the responsibility to disclose the facts of events as they occurred during the trading period in the financial statement. There are various activities happening in business and in order for the stakeholders to understand them accountants should gather relevant facts about the business and present them to the stakeholders in simple way for them to understand and use (University of Leicester, 2009). Therefore, representation of facts should reflect fair value of the business activities. It enables the business to forecast the outcome of business activities, and aid in decision-making rather waiting to make immediate managerial decision. In addition, representation enables accountants to interpret complex accounting issue for easier understanding. For example, if the organization’s stocks are undervalued the accountant should make the managers aware of it and advise them on strategies to improve increase its sales. Finally, accountants control business activities. Control involves the practice of examining and directing actions by observing and regulating of activities in exercise of accounting power (University of Leicester, 2009). They scrutinize various business activities and provide the managers with a proper course of action to take in order to avoid loss or tap better opportunities existing in other areas of the economy. Accounting guides the preparers of the financial report to translate operations of numerous organizational elements into the set of data taken to represent the goal that varied components can be used to match the performance of departments and units (Hopwood, 2009). The comparison provides an overview of the efficiency and effectiveness of resource allocation. Therefore, accounting enable stakeholders to gain clear understanding business operations by simplifying complex elements, arranging the disorganized data and disclosing what is unknown for effective decision-making (Saravanamuthua & Tinker, 2003). However, accountants are guided by the accounting principles in decision-making. When preparing and presenting financial information analysts are guided by various accounting principles. For example, the use of accruals accounting method that evaluates business performance and financial status by recognizing economic events irrespective of when the cash transactions took place (Froud et al., 2004). Accountants apply matching a principle that requires them to match revenue with expenses related to the period when operation took place instead of the period when the payment was made (Froud et al., 2004). This provides an opportunity for merging the firm’s present cash flows with the expected cash flows. It gives the users of financial reports an accurate prediction of the present status of the business to enable them make the informed decision (Roberts, 1991). The use of comparability involves interpretation of the financial information is compared to the reports of the previous accounting period or the financial reports of other firms in the same industry (Chwastiak & Young, 2003). Therefore, accountants must ensure they apply uniform procedure when preparing a financial report in order to enable its comparability. Also, the use of going concern principle creates the presumption that the business will carry on with its activities in the future, and there is no impediment to its trading activities that could lead to insolvency of the business (Arnold, 2009). Therefore, the indicated business assets are construed to have capacity to generate returns in the future. Finally, the principle of reliability requires that when preparing financial report accountants should exercise prudence in assessment of profits and valuing the assets. For example, the company should declare profit should after the making sales (Roberts, 1991). On the other hand, the organization should declare loss immediately after they recognized it even though it will occur in the future. Also, accountants should write-off any debt they are doubtful about debtors’ capacity to pay and should write down any stock that has become obsolete (Roberts, 1991). The business adherence to this principle increases the credibility of the financial report hence its reliability. During various business operations, the senior, middle and lower level organization managers engage in various scandals that could have social, legal or moral implications of organizations or individual workers (McSweenn, 1997). Those scandals may range from flaunting accounting regulations, environmental degradation, supporting of deceitful practices, organizing discriminatory employment practices, etc. (Catchpowle et al., 2004). Managers commit frauds in financial statements in order to mask the actual performance of the business, to maintain individual earnings and treasure, and to secure their individual position and governance. They misrepresent financial statement in order to conceal the actual performance of the business and enjoy performance-based benefits (Roberts, 1991). Also, they do so in order to obtain loans or increase the prices of goods and services to the target market. In order to achieve their goals, preparers of a financial report formulate figures to inflate revenues, cover liabilities, and expenses, make improper valuation and reporting of the assets and make inappropriate financial releases (Arnold, 2009). Unfortunately, auditing of a financial report is not reliable method of detecting financial frauds or manipulations of the financial statement (McSweenn, 1997). Investors have serious concerns about fraudulence in financial statement because it could have significant effects on the future survival of the business and the market value of the company’s products or stock (McSweenn, 1997). JPMorgan is the US largest bank by assets and is an incorporated company that offers commercial and investment banking services (ABC, 2014). The bank was engaged in fraudulent activities that led to a loss of over $6.2 billion as a result of inflated trading bets. This was a demonstration of trade violations that infiltrated all levels of management at a portfolio level to the senior management level. According to ABC (2014), JPMorgan Chase was involved "in unfair billing practices for certain credit card and add-on products by charging consumers for credit monitoring services that they did not receive” (ABC, 2014). The conducts of the company had serious accounting implications involving the accounting activities of accountability, representing and control. The conducts of JPMorgan was in violation of Volcker Rule that prohibited commercial banks and lending institutions from engaging in high-risk trading (ABC, 2014). However, the execution of trades was carried out in one of the JPMorgan’s Units that reported directly to the CEO Jamie Dimon, who determined what information would be revealed or withheld from the regulators. Therefore, trades took place into the office of Chief Investment Officer (CIO) and the staff was carrying out “the orders of risk investment officers and executing the strategies of the bank’s risk management mode” (ABC, 2014). The bank failed to protect its traders resulting to overvaluing of the portfolio in order to cover up the massive losses they were making (ABC, 2014). They had weak accounting controls, and the senior managers withheld critical information from the regulators hence they failed to provide auditors with sufficient information that could assist them in discovering the ongoing fraudulence in time during its operations. Consequently, the auditors were unable to ascertain the accuracy of a financial report (ABC, 2014). The organization’s insiders came to a realization that the aggressive marketing activities had the adverse effect of the credit default swaps. Boaz Weinstein, one of the hedge fund insiders of Saba Capital Management, recommended the buying of CDXIG9 to his investor audience during Harbor Investment Conference in February 2012 (ABC, 2014). CDXIG9 is a market derivative that evaluates the variance in interest rates among the prominent companies and London Interbank Offered Rate (LIBOR). Weinstein’s advice was unpleasant because he was aware those derivatives were losing their market value at a rate that would result in deviation from the market anticipation (ABC, 2014). JPMorgan was making huge trades that were shorting the index with a bet that that credit market would grow stronger. Early investors were making loss as JPMorgan cling to their position in the market. However, by May 2012 the investors had increased concerns about the consequences of the European Crisis and that altered the market situation resulting in the huge loss by JPMorgan (ABC, 2014). JPMorgan incurred large trading loses at the Chief Investment Office related to transactions booked by its London Branch. The Chief Investment Officer Ina Drew entered a series of credit default swaps (CDS) as a hedging strategy against trading loses (ABC, 2014). Consequently, Bruno Iksil, a trader accumulated enormous CDS position in the market. Although the investigations are underway to establish the cause of loss by JPMorgan, the company has already taken the responsibility and has accepted to pay a fine (ABC, 2014). The scandal involving JPMorgan was due lack of accountability by the accountants who did not act in good faith. They failed to advise the managers to on the strategies to use in order to strengthen the market position of the company. Also, the representation of the financial report was not made to the appropriate stakeholders. For example, the chief investment officer had the power to decide what information to release to the public and kept secret some of the vital information thus they denied stakeholders an opportunity to make effective investment decisions. Finally, accountants failed to provide control of business activities because instead of directing managers on appropriate decisions to take the Chief investment officer limited the activities of the organization by withholding some of the information essential for controlling the activities of the business. Nomura Group is of Japan’s largest financial corporation with an extensive combination of products and services such as capital investment, IPO underwriting, securities and asset management. In 2010, there were claims that the bank was involved in dubious activities (Barnes, 2014). Three companies; Tokyo Electric Power, Inpex and Nippon Sheet Glass reported the suspicious trading activities prior to issuance of new shares in their companies. Following those claims the Japan Securities and Exchange Surveillance Commission (SESC) launched an investigation that led to unearthing of insider trading involving Nomura sales officers. Although it is the duty of the accounting unit within the organization to disclose all material information to the stakeholders that can assist them in making economic decision, under insider trading those entrusted with relevant information do not disclose it to the intended stakeholders, but instead they use it for personal gain. In 2010, Nomura engaged in various underwriting deals that had distrustful trading activities reported before the issuance of new shares for the organizations involved in the deals (Barnes, 2014). Earlier in the year the sales representatives had shared critical information regarding the planned public offerings whose Nomura was an underwriter with hedge fund managers and bankers outside the Nomura. The hedge fund managers benefited from the information they acquired from insiders by shorting the stock of the issuing companies and repurchased the shares at lower price after the release of the new shares to the market (Barnes, 2014). Apart from the desire to make more profit the sales representatives may have shared critical information with outside firms in order to meet their sales targets. Nomura faced severe consequences for disclosing confidential information. The consequences include delisting of Nomura from the list of underwriter and its fining of $2.5 million (Barnes, 2014). In this case, the accountants failed in their role of accountability because they acted unethically by sharing business information with the external parties who used the information for personal gain. Also, the representation of the financial report was not made to the intended recipient, and that resulted to some stakeholders benefiting from that information while others were losers because of inadequate information. Finally, accountants did not use the actual information to control the activities of the business in order to generate the benefits for all stakeholders. In conclusion, accountants have significant roles to play in ensuring the business conduct its activities with full information about the business position and predicting the future of the business. They provide information stakeholders in the timely manner in order to guide their decision-making process. They should be answerable for their actions and be guided by ethical principle in order to ensure the information, they share with shareholders, represent the true financial position of the company. For example, in the case of JPMorgan and Nomura Group the accountants failed to observe their role and consequently plunged their companies into severe financial conditions. Therefore, accountants should share reliable information with the stakeholders and avoid withholding any information that may affect stakeholders’ decision-making practices. Bibliography ABC, (2014). JPMorgan Admits Wrongdoing in ‘London Whale’ Trading Scandal, Fined more than. 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