The Sarbanes Oxley Act: Boon or Bane - Case Study Example

The Sarbanes Oxley Act: Boon or Bane 1. Introduction This paper seeks to discuss the following topics: “The Sarbanes Oxley Act: Boon or bane” “WorldCom Financial Reporting Fraud”, “Enron: What happened and what lessons can be learned from this?”, “ The downfall of Arthur Anderson” and “ Accounting for leases” . These topics involve the use or concept of accounting in the world of business and thus this paper tries how accounting a relevant role was made a part in the analyses and discussions that follow. 2.1. The Sarbanes Oxley Act: Boon or bane. To judge a law whether it is benefit or an annoyance must consider some time frame. Those who believe that Sarbanes Oxley Act (SOX) has become a bane or a disadvantage rather than a boon or advantage argue for the problems created by the law by increasing the cost of doing business (Platt, 2004). Their frame of reference of course is purely economic where what cost a business more should not be done because the same would be cost inefficient and firms become uncompetitive. Since the law would apply to the companies operating in the United States, it is argued that US companies would rather get out of the US so that they would spend less cost in doing business. On the other hand, those who argue that the law was passed to protect investors and the cost of having the same must be a necessary consequence if they people in the business want to protect their investors. The lawmakers who crafted the legislation are presumed to have good intentions when they enacted the law. Lawmakers who represent the investing public believe that the SOX can end fiscal abuses of the past years particularly the cases of Enron and WorldCom where the key officers of the corporation with the connivance of auditors can really make of fool of the investing public in manipulating accounting information with less restriction (Platt, 2004). SOX therefore basically works on the premise of putting more requirements to increase the regulator power of the Securities and Exchange Commission (SEC) and other regulators to possibly prevent in the bud financial and accounting problems from becoming too wide in their fraudulent consequences before the corrective action could be done. The effect therefore of SOX could not be easily seen in terms of whether it could prevent another Enron or WorldCom fiasco. This paper therefore considers the arguments of both sides of the coin but resolution on which should win should depend on what period time should be made as reference. Since time will be the better arbiter, judgement is reserved due to not being able yet to have that longer time to judge the more complete effect of SOX. 2.2. WorldCom Financial Reporting Fraud By manipulating the accounting information, one can become wealthy in terms of rising stock price especially if done by a chief executive officer of a company with the participation of key officials in the organization, who are supposed to be responsible to the objectivity of accounting information. This is what actually happened in the case of WorldCom where its CEO Bernard Ebbers took advantage of this position in the company by reporting accounting information different from their objective or reliable form. Starting from about mid-year of 1999 and continuing at hastened pace until May 2002, the Ebbers in coordination or with knowledge of some of its key officials including its chief finance officer , its comptroller, and director of accounting, employed fraudulent accounting methods to cover the firm’s deteriorating earnings by portraying an untruthful picture of WorldCom’s progress. The officers faked profitability to bolster the price of the firm’s stock (Brooks and Dunn, 2009). The scheme accomplished the deception primarily in two ways. First, it underreported expenses of interconnection with fellow telecommunication companies by make the most of these costs as assets to bolters financial position rather than properly recognizing them as expensed in the profit and loss or income statement. Second, it bloated revenues with using fake accounting entries (Brooks and Dunn, 2009). Accounting information is supposed to be reliable and objective to be used by decision makers in assessing the attractiveness and risk of stock investments. In case of WorldCom, it officers which were agents of the corporation abused their functions and tried to lived their selfish ways by manipulating accounting information for personal gain at the disadvantage of other stockholders and investors. 2.3. Enron: What happened and what lessons can be learned from this? The case of Enron is not far different from WorldCom with the manipulation of accounting information by not recognizing in the books what should have been reflected. The company resorted to just disclosing off-balance sheet financing transactions (Laskin, 2010), which it tried to justify as one that should be allowed under then applicable accounting standard but the fact fall short in satisfying the real nature and purpose of accounting information which is to afford decision makers a fair ground to make their decision in assessing attractiveness and risks of their investments. Accounting and its use should therefore be correctly blamed for the losses sustained by investors as a result of the collapse of Enron which may be a fair criticism for reforming financial accounting and reporting practices in the economic world. The lessons that could be learned is the vague of accounting standards because of their general nature which could actually encourage creative accounting and which could actually result to manipulated accounting information. On whether it matters that accounting policies that are adopted by a company are allowed as long as they are adequately disclosed as argued by Enron should be rejected. It can be counter argued that accounting policies matters may represent the methods, principles, practices, rules, bases and conventions adopted by an enterprise in preparing financial statements. Said accounting policies should not only be disclosed; they must be complied with also with the very heart of generally accepted accounting principles. To require companies to disclose only would be encouraging a gray area where a manipulation by those who prepare the financial statements is easy. By merely disclosing off-balance sheet transactions with the go signal of Arthur Anderson as auditor, Enron had in effect understated its liabilities in the balance sheet which produced the manipulation in the minds of the information users. In simple words, it was a deception. 2.4. Accounting for leases. Accounting information is being required to be objective and reliable despite the presence of the use of estimates in the financial statement representation by the preparers of the financial information which must be supported with evidence. The seemingly conflicting realities -- to be objective and being allowed to used estimate -- would have to be tested in this accounting for lease. Accounting for lease allows two possibilities of recording lease transactions. One may record the same as expense or asset. Making choice however is not a matter of discretion but is governed by Financial Accounting Standards Board under FAS no 13 and was made effective in 1977 (Ellis and Pippin, 2007). To record the same as rent expense, the contract between the lessor and the lessee must be under an operating lease with a lease term that may extend to even one year. This would require a credit to either cash or rent payable after debiting an expense. If the same lease qualifies as capital lease, the recording as expense would not be proper. Recording the same as asset in the balance sheet would therefore the proper way to do it. But not recording it as an expense, the income statement would be of fewer expenses and therefore net income would normally be higher than when the same is recorded as an asset in capital lease. Together with the recorded asset is the need to record a long-term liability. The effect of this transaction would be to increase long-term capitalization that could affect the capital structure of the organization but leaving the income statement less affected than recording the same as expense under an operating lease. Depreciation still needs to be recognized. However to determine the correct decision whether to record as expense or asset is governed by accounting standards on lease. One requirement for capital lease for example include the presence of bargain purchase option at the end of lease. Another is that the lease term is relative long in relation to life of the assets. In this case the use of estimates as to the discount factor to bring the minimum lease payments may involve and estimate for purposes of determining the fair value of recording asset, there is still objectivity information when validated with other information which the company may must have including its capital structure. The accounting standards therefore try to approximate a balance between objective information and relevance of the information to decision makers. 2.5. The fall of Arthur Andersen To talk about concepts of the discretion on the use of accounting based on standards on whether there is significance as far as those involved in insuring the integrity of the said information is concerned would be best appreciated if responsibility can be demanded. It is therefore very relevant and interesting to talk about the fall of a well-known person or entity in the accounting world in failing to appreciate or give appropriate course of action to an event or series of events that would require the application of objective and reliable information. Arthur Anderson was a big entity in the auditing world with the role of ensuring the objectivity of information through audit of financial accounting information prepared by its clients. One that would explain the cause of the fall of Andersen was the deviation from the supposedly purpose and philosophy of audit to favor the other way, by shifting to becoming more of business advisor than as auditor that assures users of information on the reliability of accounting information. It could thus be traced from records that Anderson chose to remove people who are good in audit and favor those that would the auditing firms as one providing consultancy rather than audit (McRoberts, 2002). Wittingly or wittingly the resulting events were disastrous at it resulted to having to necessarily compromise the integrity of audit because of the lure of more business transactions with client. Anderson may have failed to appreciate the need to separate audit from consulting or to separate the function of giving assurance to users and giving assurance to clients that could result do injury to stockholders and the investing public. Andersen was even prosecuted for lying, which is the greatest evil to the practice of accounting profession, since the latter must be necessarily connected or tied with the values of integrity (McRoberts, 2002). 3. Conclusion This paper has found that the accounting has played a big part in business. In SOX, the determination of whether the same is bane or boon necessarily involved the importance of the work and responsibility of CEO and CFO who must certify to the truthfulness of the financial information and fact the accounting may involve estimates may make it difficult to treat accounting information as purely historical. In WorldCom financial reporting fraud, the accounting information was being manipulated to influence stock prices and same could be said in the case of Enron. This paper has discussed the accounting for leases; where there are criteria used for classifying lease as expense or assets and would necessarily affect the reliability or objectivity of information in the financial statements. It could thus be seen that information may not be exact because of the use estimates, but the fact that standards are made and implemented by regulators should convince information preparers that a certain degree of objectivity of the accounting information is reasonably possible in theory and in practice. The downfall of Arthur Anderson as an auditor underscores the need for objective information that would help in the decision making which should be completely separate from the providing consultancy service. References: Brooks and Dunn (2009). Business & Professional Ethics for Directors, Executives & Accountants A. Cengage Learning Ellis and Pippin (2007). CCH Accounting for Leases: Interpretations of FASB Statement No. 13, Accounting for Leases, as Amended Cch Accounting. CCH Laskin (2010). Investor Relations. Business Expert Press. McRoberts (2002). The Fall of Anderson. Retrieved 12 March 2011 from http://www.chicagotribune.com/news/chi-0209010315sep01,0,2011837,full.story Platt (2004). Sarbanes-Oxley: Bane of Boon?. Workspan. . Retrieved 12 March 2011 from http://www.executiverewards.org/exec_library/adimLink72.html Read More