Issues in Accounting and Finance - Enron and Satyam Scandals - Case Study Example

Issues in Accounting and Finance Table of Contents Overview 3 Accounting Ethics 4 Implication of Past Accounting Scandals 5 Enron Scandal 6 Satyam Scandal 8 Effectiveness of increased regulation 9 Conclusion 9 References 11 Overview The principles of business ethics assist business organizations to augment their positive outcome, at the same time as reducing or controlling the ill impacts of their business operations on the society as a whole. Even though, business ethics is recurrently used as an alternative of corporate social responsibility in the business context, it is crucial to understand that business ethics is actually related to business decisions that the society in general deems as right or wrong. The significance of business ethical behaviour in the interest of the society is greater than before in the present-day competitive business environment. Currently, when there is widespread economic uncertainty, businesses have to face a number of challenges ranging from global competition, up-to-date technologies, need for enhanced product and service quality, efficient management and motivation of diverse human resources, in addition to the challenge of ethical behaviour. The imperatives of daily business performance are so absorbing that the management of organizations generally are not left with much time and tendency to emphasize on the moral content of business decision making (Sims, n.d.). However, unethical business behaviour and non-compliance of the prescribed ethical norms may result in higher costs for business organizations. This is because non-conformity to ethical standards can result in threat to the company’s name and goodwill; it would increase the risks as well as the costs, hamper performance and productivity leading to decline in competitive position in the market. Moreover, the reputation of the company and the confidence people have on it would be badly affected, impeding the long term growth and sustainability of the company. Owing to the increased significance of business ethics, there has been increased regulation so ensure that business organizations follow certain ethical standards. However, it has been widely opined that increased regulation would not essentially result in superior ethical standards amongst corporate organizations. This paper would discuss this idea, relating it to the happenings of the corporate world. Accounting Ethics The theory of accounting ethics had developed of late following the incidence of number of high-status and publicly discussed corporate scandals that led to the collapse of organizations like Enron and Worldcom. Government and other financial regulatory bodies have been attempting to augment the regulation and monitoring of corporate organization with the purpose of ascertaining the safety and security of the interests of the common public and the protection of business ethical behaviour on top of social responsibility in the business surroundings. It is at the present compulsory for publicly listed companies to publicly disclose their audited annual accounting reports, comprising of complete financial information of the organization. The primary objective of business ethics monitoring consists of the formulation of regulatory policies that aims to safe guard the interests of the society as a whole. Thus, in relation to the earlier years, the current business and regulatory environment is comparatively more conductive to ethical behaviour. The business environment that exists presently throughout the world, calls for a strict regulatory setting and observance to ethical standards norms, for organizations and the overall financial system to sustain in the times to come. The last couple of decades had seen the introduction of a variety of regulations, particularly that relating to the auditing and accounting segment of corporate organizations. However, the regulatory bodies believe that the global financial and economic depression that lasted from 2007 to 2009 had pointed out considerable negative aspects in the audit system followed worldwide and particularly that is exercised in the Europe. As a result, the European Commission believes that there is serious need for more stringent regulations because it has been observed that large numbers of business organizations were found to have been termed clean by their auditors, notwithstanding the fact that those organizations had serious non-compliance and other financial issues. Consequently, the European commission had proposed a number of new or revised regulations to further enhance the independence of the auditing profession and hence simultaneously improve the ethical standards (Murtagh, 2012). Implication of Past Accounting Scandals Compliance with the audit standards is a regulatory obligation that every corporate organization is required to put up with. The audit report is an independent report prepared by external auditors subsequent to collecting and assessing facts from publications and statements related to the company’s financial activities and business dealings. Subsequent to the assessment, the auditors find out the degree of abidance by the company in its financial declarations in relation to the mandatory auditing standards, and establishing their observation by means of the audit report. However, there are historical evidences that many a times in spite of the accounting and auditing regulations that are in place; there have been many large scale corporate accounting scandals. This had given rise to widespread discussion that the enforcement of regulations would not necessarily mean that ethical standards are maintained by organizations. In order to gain an insight of the issue in the business context, this section of the paper would focus on the accounting non-compliances that took place during some of the famous corporate scandals so as to comprehensively understand whether the implementation of regulations could have ensure a superior ethical behaviour for those companies. Enron Scandal Enron was instituted in the year 1985 and over time it had extended its business from natural gas transportation to energy trading derivative markets. In the latter part of 1990s, like many other organizations, Enron had also made a great deal of investments in order to enter the internet markets. The management of Enron had taken up huge external loans for its dot com venture and hence consequent to the dot com crash in the year 2000, the company encountered huge losses. Simultaneously, Enron also faced substantial losses in some of its overseas business operations. Despite the fact that Enron’s core business, that is, energy trading was doing reasonably well, it was not sufficient to balance the damages encountered in its dot com as well as its other overseas ventures. During this time, the management of Enron, rather than disclosing its actual financial scenario to its investors and other interested parties, published erroneous and misleading details in its financial statements. The Chief Financial Officer of Enron created special purpose entities and allotted the business losses and almost valueless assets to those entities, which required no financial reporting (Bauer, 2009). Besides this, the management of Enron also disguised its bank loans as dealings in energy derivatives to conceal the extent of loans it had take up. These accounting misappropriations were carried out for almost about two years, and when it was finally made public, it was found that over 80% of Enron’s disclosed earnings since the year 2000 did not even exist. This led to the fall of Enron, resulting in huge number of job losses, along with massive loss of investor wealth. There was an obvious principal agency issue at Enron. The top level management of Enron disregarded the interest of the common investors and misused their position and authority to build up wealth through advanced sale of stocks, whilst the other stakeholders later had to suffer massive losses due to non revelation of actual financial performance of the organization (Petrick & Scherer, 2003). The board of Enron overlooked the corporate governance regulations and allowed its Chief Financial Officer, Andrew Fastow, to form private enterprises to do business with Enron. The dealings with those enterprises were utilised to conceal the losses and debts of the company, and thus the disclosed earnings of Enron were erroneous (Vinten, 2002; Jickling, 2002). Arthur Andersen was the then auditor of Enron and therefore it was its responsibility to make sure that Enron’s financial statements were a fair reflection of its real financial position. However, the audit company had overlooked the discrepancies and given a clean chit to Enron. In this context, it should be mentioned that Arthur Andersen also acted as the consultant of Enron, besides being its auditor. For this reason, researches point towards a conflict of interest arising at Arthur Andersen, which had questioned the independency and validity of the audit reports prepared by Arthur Andersen’s (Patrick & Scherer, 2003; Bauer, 2009). Hence, it can be inferred from the Enron Case that only the existence and implementation of accounting regulations is not enough to ensure that business houses abide by ethical practices. Satyam Scandal Another recent accounting scandal that took place recently is the scandal associated with Satyam Computers Services Ltd. The company was founded in India in 1987 by B. Ramalingla Raju, its founder and chairman. The organization functioned in the information technology and business process outsourcing sector across many industries. During the period 2003-2008, Satyam performed highly in relation to finance and business. Satyam’s revenue during the 2008 was over $2 billion. Nevertheless, during the later parts of 2008, it was revealed that the profits of the company were actually much higher than what was disclosed. The Chairman of Satyam had in fact tunnelled the earnings of the company through self-dealings. The real returns of the company were much superior than that were disclosed in its financial statements. B. Ramalingla Raju, the chairman of Satyam, utilised the concealed proceeds of the company for personal benefits, and had also opened a number of fabricated salary accounts of missing workers and used that cash for private dealings. In case of Satyam, nobody other than the Chairman and his direct family had access to total company information. This was a case of unethical business practice and disregard of the accounting and auditing standards. Consequently, the major loses in this scandal had to be bored by the common investors, despite the fact that the promoters of the company benefitted illegitimately from the money that actually belonged to the shareholders. Consequently, it can be comprehended that the Satyam scandal was a select case of disrespect of fiduciary liabilities, complete disregard of ethical norms and nonexistence of corporate social responsibility by the promoters of the organization (Shihur, 2011). Effectiveness of increased regulation To lessen the risk of any impending conflict of interest, regulatory bodies like the European Commission had proposed number of revised regulations. This include the mandatory rotation of external auditing firms and the limitation of non-finance services they provide to the companies, for which they perform the audit as well. These proposed reforms have their share of advantages as well as disadvantages. However, organizations do not realise their responsibility towards their shareholders and the society on the whole, it is likely that no amount of regulation would ensure a superior ethical conduct. The basic rationale of the implementation of regulations consists of the creation of a business environment that aims to safe guard the interests of minorities’ shareholders. It has become very imperative to defend the trust of stakeholders and prospective investors, as they are one of the most significant elements of the whole financial system. The investors are prospective shareholders and from the investment point of view, they can be segregated into two classes- individual and institutional. As a result, business organizations must attempt to develop sufficient confidence with reference to a market’s stability. Conclusion The quality and reliability of audit report and observance to the approved practices of audit standards has been a subject of debate in the corporate surroundings. Observance to audit standards practice assists an organization to reduce its risks in addition to augmenting its business performance at the same time. In the present day aggressive business environment that calls for a stern regulatory setting, obedience to audit standards and policies helps businesses to maintain themselves in the long duration (Samontaray, 2010). However, whether a particular organization abides by ethical accounting practices is a matter of integrity and cannot always be ensured by means of enforcement of stricter regulations. References Bauer, A., 2009. The Enron scandal and the Sarbanes-Oxley-Act. Germany: GRIN Verlag. Jickling, M. 2002. The Enron Collapse: An Overview of Financial Issues. CRS Report for Congress. Murtagh, B., 2012. The Auditing profession - independence, quality and reforming the regulations as proposed by the European Commission [Pdf] Available at: http://www.icac.org.jm/pdf/Presentations_2012/The%20Auditing%20Profession%20-%20Independence,%20Quality%20&%20Reforming%20the%20regulations%20as%20proposed%20by%20the%20European%20Commission%20by%20Brenda%20Murtagh.pdf [Accessed on November 16, 2012]. Petrick, J. A., & Scherer, R. 2003. The Enron Scandal and the Neglect of Management Integrity Capacity. Mid-American Journal of Business, Vol. 18, No 1. Samontaray, D. P., 2010. Impact of Corporate Governance on the Stock Prices of the Nifty 50 Broad Index Listed Companies. International Research Journal of Finance and Economics, Issue 41. Shihur, S. (2011). Tunneling vs Agency Effect: A Case Study of Enron and Satyam. Vikalpa, Volume 36, No 3. Sims, R. R., No Date. The Challenge of Ethical Behaviour in Organizations. [Pdf] Available at: http://download.springer.com/static/pdf/581/art%253A10.1007%252FBF00881442.pdf?auth66=1353044529_3e854ab0e032781ebdff92eef7040358&ext=.pdf [Accessed on November 16, 2012]. Vinten, G., 2002. The Corporate Governance Lesson of Enron. Journal of Corporate Governance, Vol. 2(4), pp 4-9. Read More