Accountability.

Case: Putting Accountability Back Into Public Accounting

CASE SUMMARY

How did a vocation such as accounting, which is heavily rooted in being accountable for one’s actions become mauled in copious, public scandals over the past decade? Obviously, people are people, and people are fallible creatures; however, the recent string of financial abuses can be likened to corrupt cops or government pilfering. Much trust is instilled in an accountant to be honest and forthright, reporting true and accurate financial information about a company. When that trust is broken, stakeholders demand answers: Which factors lead to such blatant disregard for the core mantra of the accounting world?

Power. Greed. Control. Money. These vices are all contributing factors leading imperfect people to commit fraud and perjury, leading to the collapse and fall of such once-mighty titans as Arthur Anderson, WorldCom, and Enron. Some auditors are misled on purpose by their clients; others turn a blind eye in exchange for lucrative consulting services contracts. Still, other auditors may be putting forth an honest effort to examine a client’s books, but may not be performing due diligence – and as some claim, may not be looking in all the right places for erroneous bookkeeping entries.

Prevailing legislation aims to put a clamp on financial reporting transgressions and develop quality of earnings with such efforts as the Sarbanes-Oxley Act and numerous other SEC stipulations. As with most intensely debated issues, the best methods for achieving an honest and fair accounting standard are argued from both sides of the fence. Government officials believe the American Institute of Certified Public Accountants is taking sides with the members it represents; accountants feel they are the best educated to scribe the most effective accounting rules. Somewhere in the middle lies an answer.

Just as the accounting equation needs to remain balanced on both sides, so does the accounting world and the numerous clients it serves. Accountants cannot be chartered reliably if they are so easily corrupted, and businesses can’t project a trustworthy image to its shareholders when the business engages in questionable accounting practices. That is one equation that is not in balance.

If accounting firms are to remain objective and fair, providing accurate and reliable analysis of a company’s financial information, they can’t do so consistently if they are concurrently offering management consultations to their clients. When a business enlists an accounting firm to provide management consulting services and audit the company’s books, a conflict of interest occurs. The auditors aren’t going to look a gift horse in the mouth.

The auditors want to retain the consulting business of the firm, so the accountants are more likely to be influenced to doctor books or turn a blind eye to compliance infractions. Just as WorldCom executives felt a pressure from stakeholders to continue being a profitable venture, accounting firms entangled in consulting contracts with clients they are responsible for auditing can be pressured to make unethical decisions that benefit those clients and, ultimately secure the contracts coming in.

In the near-term, one could argue that the services would increase revenues of the accounting firm, thereby creating higher paying jobs, injecting more money into the economy and such. Unfortunately, one bad onion spoils the soup. With the rash of recent accounting scandals, and an already bruised reputation among the general populous, the accounting system simply cannot risk any more “back door back-scratching.” Pure and simple: the risk of performing the management consulting services is arguably too high, when compared to the summation of the perceived benefits. The most effective way to avoid a potentially corrupt scenario is to abstain from it altogether.

All of society has needs. To meet these needs, businesses exist to provide society with jobs, necessities such as building materials, water, and food, and payment for goods and services in the form of cash as a means to prosper. Businesses also contribute to the economic system by paying taxes, and reinvesting any profits back into the economy in the form of either payments to shareholders, capital expenditures, or charity donations, thus increasing a nation’s wealth and standard of living.

The accounting system ultimately assists managers make informed decisions about controlling a company’s operation and aids stakeholders assess the business. Other business institutions such as lenders, investors, suppliers, and even employees rely on accurate accounting information in their dealings with the company. Employees may examine a balance sheet to see if the company is expanding or to determine whether or not executives are receiving raises while the worker bees are not. Investors may rely on accurate financial information such as an income statement, balance sheet, and cash flow statement to ascertain if the company is a viable investment vehicle.

With so many individuals and corporations relying on each other, the auditing function is vitally important to the global economy because it serves as a check and balance system – ensuring companies are reporting accurate, non-manipulated financial information. While an individual company may stand to benefit in the short-term by “cooking its books,” in the long-term hundreds of millions of people stand to lose. Case in point, the effect of Enron’s erroneous accounting reporting affected the lives of hundreds of thousands, from individual employees, to investors, to suppliers, manufactures, city, county, state, and federal governments who rely on tax payment revenues, and the entire U.S. population who had to absorb some of the costs related to unemployment programs.

Additionally, WorldCom’s bankruptcy put 55,000 individual employees at risk for losing their job and, along with it, their means to prosper, ability to pay taxes, and reinvestment of money back into the economic system. Protecting those jobs was so important that it was part of the WorldCom bankruptcy agreement in 2002. It’s in everybody’s best interest to keep unemployment rates as low as possible as this reduces the tax burden on citizens, injects money back into the economy, and provides a means for people to purchase more goods and services – ultimately creating or sustaining jobs.

Without accurate accounting or auditing functions, the current economic state is blurred and it is nearly impossible to gauge just how well or poor the economy fairing. An altered or inaccurate audit report is akin to a building foundation that is comprised of straw and mud. While a foundation exists, it belies the actual stability of the building that stands on that foundation. Eventually, pressure and time will erode the counterfeit underpinning and, depending on how large the infrastructure is, the entire global economic system will feel the rippling effect of the foundation’s collapse.

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