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Accounting in 21st Century - Term Paper Example

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The paper “Accounting in 21st Century” is an impressive example of a finance & accounting term paper. The accounting profession has been under severe scrutiny all over the world for a decade ever since the fall of Enron, World Com in the U.S., and HIH Insurance in Australia due to artificially created rosy financial pictures of these publicly-owned corporations…
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Accounting in 21st Century Accounting profession has been under severe scrutiny all over the world for a decade ever since the fall of Enron, World Com in the U.S. and HIH Insurance in Australia due to artificially created rosy financial pictures of these publicly owned corporations relying on which the public had invested their money on the shares of these corporations. But for the connivance or negligence of the accounting profession, this could not have been possible. When the so called financial bubble burst, the creative accounting practices of the companies were exposed. Brief Background History of American accounting is traceable to English Accounting which took cues from the accounting concepts of Rome and Egypt. Egypt which had the system of scrutiny of accounts by engaging two taxation officers ultimately resulting in fiscal control was followed suit by Rome by introducing cross checking of each other between the officers in charge of revenue expenditure and expenditure authorization. Thus the practice of keeping two identical records by two different persons to trace mistakes developed. The British adopted this kind of audit in due course. British Statutory audit has its origins to the medieval practice of verification of trustees-managed farm transactions by outsiders. During the fifteenth century, this practice of independent checking of accounts spread to upcoming publicly owned companies who were accountable to outsider shareholders. Thus the purpose of accounts verification was to keep track of how the companies were run by the independent directors wherein also lay the auditors’ duty to identify financial malpractices disclosed by accounts. (De Ridder J) This led finally to the emergence of enactments in England in 1900s requiring publicly owned companies to be audited by the representative investors.(Chatfield M 1968) A case decided in 1887 (Leeds Estate 1887) paved way for directives mandating audit. For example, the decision in Leeds Estate case stated that books of accounts of the companies should be verified for the presence and value of reserves. (Chatfield M 1974) Then came the Companies Act 1907 in England requiring the filing of audited balance sheet with the authorities and also to be made available to the shareholders. The Act of 1928-29 stipulated that companies must also produce their annual income statements to the share holders besides segregating current assets from fixed assets in the balance sheet along with the report of auditor for any fresh share offers and mergers planned, and loans to employees. From 1948, professionally qualified auditors alone could furnish reports to the effect the company’s books audited disclosed the ‘full and fair view’ of its fiscal affairs. Then consolidated financial statements were required to be filed. Gradually also developed, a system of granting auditing tenure at each annual meetings of shareholders. Thus auditor came to be known as an independent authority. (Chatfield M 1974). The above British tradition being a forerunner to American auditing, the United States relied less on statutory directives and more by creation of professional accounting societies. Thus American Association of Public Accountants (AAPA) came into being on Sept 20, 1887 at which time official title for qualified accountants were not in existence.(Zeff Stephen 1972) The AAPA however was responsible for the enactment of a bill for Certified Public Accountant (CPA) in 1896 which prohibited unqualified persons to use the title of CPA. Though to begin with no qualification and experience were prescribed for becoming a CPA, interviewing of the applicants for suitability was adopted. (Carey L 1969). Later in 1906 the association published bylaws for ethics and discipline in the profession advising the CPAs not to engage themselves in employment of conflicting interests, and issue soliciting advertisements. Yet the directives were not authoritative enough to enforce discipline among the accounting profession. In 1914, when the Federal agencies wanted to create standards and a register for public accountants who complied with those standards sought to be created, the AAPA reacted by reconstituting itself as the Institute of Accountants in the USA and gazetted the first ever auditing standards for the U.S in the name of Uniform accounting by 1917. Subsequently in 1923, the institute brought into force rules and procedures for certification of financial statements containing transactions after balance sheet date. This gave rise to rules for professional conduct. Later in 1930 in response to the request of the New York Stock Exchange to improve upon financial reporting in the light of varied accounting practices that prevailed at the time, the said accounting institute enforced five general accounting principles and recommended to the institute to ask the listed corporations to adopt these accounting standards and also to declare their accounting methods. The exchange adopted these standards for the listed corporations and went one step further requiring them to file their audited financial statements every year along with the scope of the audit. (Carey L 1969) After the creation of Securities Exchange Commission in 1934, it was made compulsory for financial statements of the listed companies to be audited by the Independent Public or Certified Accountant with a power to direct the companies to follow the prescribed accounting methods. Since the accounting institute was not keeping the accounting methods uniform enough to the SEC’s satisfaction, the latter started trying to develop its own uniform standards of accounting but due to practical difficulties, it issued Accounting Release no 4 informing that if the accounting principles followed by the companies were not supported by authority, their financial statements would be considered as misleading. By 1940 Code of Professional ethics had emerged and held a member of the accounting profession guilty for the five irregularities listed below. This was known as Rule 5. 1. Not disclosing a known material fact capable of making a misleading statement. 2. Not reporting a known material misstatement. 3. Gross negligence in the examination of accounts. 4. Not taking necessary information warranting some expression. 5. Not taking note of deviation in observing the generally accepted accounting principles. Auditing procedure no 23 enforced in 1947 rendered an auditor liable to express his opinion or disclaim an opinion in case of his or her name was found in a financial statement. This was further amended to make auditor give an unqualified, qualified opinion or disclaim an opinion with reasons and also to express an adverse opinion if the statement was not showing the correct situation even though there was no audit. In 1951 it was prescribed to make the member liable for disciplinary action for conniving with the use of ambiguous statements or by silence. Further a 1957 rule barred a member from practicing for own purposes besides a rule known as Rule 12 of the same year barring a member from lending his name in support of a forecast which the reader is likely to believe because of the member’s association. From 1965 a member was allowed to use work of another member who should be independent having a reputable status. Opinion no 12 which came into being in 1961 restricted a member to have any relationship which might result in conflict of interest. If the member is in service of the firm or having financial interest, he should state that his report was not in accordance with generally accepted auditing standards and that he could not therefore express an opinion on the financial statements as per a 1964 opinion No 15. All the above developments one after another were with the main objective of giving true state of affairs of the companies to the investing public and comparability of statements by virtue of uniform standards .( DeRidder J) In this connection, the Accountants Institute’s president Eaton had stated that generally accepted accounting principles developed like common law and cautioned that if equally valid alternative principles were allowed, when comparing statements of companies with one another, it would lead to a situation where in two different corporations by virtue of following different accounting methods would be found to be reporting net income differing by millions and yet the CPAs would be giving opinions that the both the statements complied with GAAP. He admitted that the corporations had the right to follow their own methods but were responsible for their financial statements and also to their bankers, Government and analysts( Carey L 1969) The SEC agreed with the Corporations’ anxiety to keep their reported earnings without being marred by the uniform accounting methods in the name of facilitating comparability as the corporations have begun to show interest the market prices of their stocks driven by stock options, acquisition prospects and the need to attract capital continually. Hence it questioned the auditors’ insistence that the corporations follow the accounting principles prescribed by them. The SEC Chairman Arthur Levit Jr had been criticising the auditing profession’s stand during his entire tenure of seven years in office. He was both called investor’s advocate and an impediment to capital appreciation. There had been a controversy whether corporations should treat stock options as an item chargeable against earnings in their profit and loss statements. While FASB (financial accounting standards board) wanted stock options to be valued at their fair market value and shown as an expense when they are issued, the companies resisted the move resulting in FASB’s ultimate directive that companies need only to disclose stock options which led to the management compensation by means of stock options. Accounting firms’ fees for consultations went up to 70% of their total revenue by 2000 as against 31% in 1998. As the auditors passed judgements on their own work having done internal audits of the firms, there was no control at all over their unethical practices. Enron had used Anderson for both their internal and external audits which investing public had found very valuable as argued by CEO of Enron. Enron & World com episodes In a brief history of the cases, Enron, On October 16, 2001 Enron declared to SEC a net loss of $ 618 million for the third quarter effectively reducing share holder equity by $ 1.2 billion. SEC opened enquiry the very next day and called for details from Enron officials who in turn notified their Auditor Arthur Andersen. Pursuant to this, Andersen had his team destroy Enron-related documents. As a result, Enron, Andersen and his lead partner Duncan were convicted of obstruction of justice. Enron’s Chief Financial officer faced indictment on 98 counts of fraud and related offences. Besides Enron is now bankrupt, and civil and criminal investigations continue to examine Enron’s complex accounting practices and byzantine financial schemes. (Brickey) Close on the heels of Enron episode, WorldCom’s fraud surfaced dwarfing the former. Both the cases involved accounting frauds with the companies managements’ sole aim of keeping the share prices higher in spite of huge losses which they covered by manipulation of accounts. But for the whistle blowers from both the corporations, the frauds would not have come to light though bubble would have ultimately burst by the operation of economics. But more money would have been swindled, more would have fled the scene had it not been for the whistle blowers who had little protection prior to Sarbanes –Oxley enactment. Enron did not fully disclose the details of transactions it had with related parties mainly that of Enron’s CFO Andrew Festow and those who worked under him. It deliberately excluded the debts of certain special purpose entities from the balance sheets and showed as sales of assets certain transactions in order to get poor performing assets out of the books of accounts though ownership remained intact without being transferred. Taking loans and showing receipt as sales proceeds and failure to disclose the extent of contingent liabilities in full, showing exchange of shares for notes as assets in order to increase equity which in fact reduced it were also being indulged in by Enron. These transactions amounted to staggering figures. The loan-cum commodity trade itself amounted to $ 7-8 billion. About $4 billion contingent liabilities was kept off the Balance Sheet. Failure to consolidate two SPEs resulted in restatement of net income for four years and amounted to $500 million. Improper hedging transactions resulted in a charge against the earning to the extent of $710 million. Improper exchange of note for stock reduced $1 billion of equity. All the above transactions were supposed to have been prevented by the Board of Directors of Enron and its Auditor Arthur Andersen who were the first lines of defence for the company. It is no surprise for Enron’s auditor to have indulged in such fraudulent activities as in the past few years 270 such incidents have taken place in the year 2001 alone. Yet compromising with the accounting manipulations, Andersen earned $ 52 million as fees from Enron for the year 2000 out of which $ 25 million was for audit work and $ 27 million for consulting services. The latter should not have been taken for services rendered as it resulted in conflict of interests as an independent auditor of Enron. However fact remains that Enron’s auditor did not verify the accuracy its accounts. As for the Board of Directors, it appointed a committee to investigate the transactions which was connected to the Enron’s Chief Financial Officer Andrew Fastow and his ex-colleagues. Permanent Subcommittee on Investigations (PSI) of the committee mentioned above held that Board of Director did not take sufficient care to protect share holder value. It investigated more than one million documents and several interview with board members who had to say the management below concealed facts from them though the Board did have knowledge of high risk accounting. Despite their inefficiency, the members of the board earned $ 350,000 per head from the company in the year 2000 which is more than double the standard wages for nationally traded corporation directors. This high remuneration must have motivated them to compromise with the management practices of fraudulent accounting. SEC which was the last resort to ensure accuracy could have done something to prevent or at least discover sooner the accounting fraud of Enron came to light. It had come to notice that Enron had at least one lobbying contact with SEC during the first half 2001. Sarbanes Oxley Act Sarbanes Oxley Act 2002 was enacted by the U.S. Government jointly sponsored by Democratic and Republican parties named after their senators Sarbanes and Oxley respectively echoing the sentiments of all stakeholders in the aftermath of big corporate frauds of Enron, Global Crossing and World com to name a few. As the corporate frauds were perpetrated with the connivance of auditors of the public limited companies, the act called SOX for short, has come down heavily up on the Auditors and Directors. SOX has changed corporate governance affecting auditors by changing the working of their firms, their audit practice and impacting their audit clients of publicly listed companies in the U.S. both U.S and non-U.S having their debt or equity securities registered with SEC under Securities Exchange Act of 1934. SOX establishes new provisions and changes existing law considerably. The enactment provides for an enhanced audit committee responsibility and auditor oversight, prior approval for non-audit services by the auditor, and disclosure of non-audit services of the auditor. CEOs and CFOs have to certify the accuracy of their companies’ annual and quarterly reports without any misleading statements besides assuming responsibility for properly evaluated internal controls. A ban has been imposed on directors and executives to avail new personal loans from their companies except certain regular consumer loans. Punishments for violations of the Act Section 802 stipulates a maximum 20 years imprisonment for knowledge of alteration, destruction, mutilation, concealment, cover up or falsification of a record or document with an intention to defeat a federal investigation or influence a bankruptcy case with or without fines. Section 904 of the Act increases the penalties for criminal violations of ERISA from up to $5,000 and/or one year in prison to up to $100,000 and/or ten years in prison. For other than natural persons, it increases the penalty from up to $100,000 to up to $500,000. Attempts and Conspiracies. Section 902 of the Act makes attempts and conspiracies to commit offences under the white collar criminal laws contained in the U.S. Code Under the same section there is a punishment of maximum 10 years with fines for knowing and wilful violation of a new audit working paper retention requirements. Section 1102 stipulates a maximum punishment of 20 years with fines for corrupt alteration, destruction, mutilation or concealment of a record or document in order to impair it’s integrity or availability for a proceeding. “Section 807 of the Act creates an additional federal felony, subject to fines and/or up to 25 years imprisonment, for knowingly executing or attempting to execute a scheme or artifice to defraud a person in connection with any security of a public company; or to obtain by means of fraud any money or property in connection with the purchase or sale of any security of a public company. The Act also increase criminal penalties for several existing white collar crimes Increased Criminal Penalties Under the Exchange Act. Section 1106 of the Act increases the penalty for wilful violations of the Exchange Act from up to $1 million and/or ten years in prison to up to $5 million and/or 20 years in prison. For other than natural persons, it increases the penalty from up to $2.5 million to up to $25 million Mail and Wire Fraud. Section 903 of the Act increases the maximum prison terms of mail and wire fraud from five to 20 years” (Orrick.2002) International Financial Reporting Standards The International Accounting Standards Board with its headquartes in London is responsible for issuing the International Financial Reporting Standards (IFRS). International Financial Reporting Standards (IFRS) have come to stay after a few decades of deliberations among the various national accounting standard setting bodies. About 100 countries have since come within the fold of International Financial Reporting Standards. IFRS are found to be of commendable quality and are backed by solid principles. The strict implementation of IFRS by self-discipline and control will guarantee improved reporting quality and decrease the quantity of interpretation required. The knock on effect will be the speeding up of decision making which must result in an improved share price for their adopters and better investment opportunities for potential investors. The proposed convergence of accounting standards will increase the flow and quality of information the lubricant on which globalization and efficient capital markets operate. Future of Accounting profession in 21st Century With the exit of Arthur Andesron, the big five became big four namely KPMG International, Ernst % Young, Deloitte Touche Thomatsu, and Price Waterhouse-Coopers who vied with one another in enrolling Arthur Anderson’s clients, with the result it was expected large number smaller accounting firms could secure new clients untouched by the big four in their preoccupation. But the Sarbanese Oxley Act’s compliance necessitated vast resources in order to perform SEC audits. Hence the smaller firms have started consolidating themselves since 2003 to have more resources at their disposal for conducting such audits. Due to divergent license requirements for CPAs among the U.S. states, an accountant has to have undergone four-year college degree course, one or two years job experience and a pass in the CPA examination. The fact of the matter is that there is a shortage of accounting teachers with doctorate degrees since most of the qualified hands take up jobs in the industry commanding higher salaries. Besides CPAs, those without college degrees also get accounting jobs of course without certification eligibility because of the growing market for the accountants. It is felt that with any downtrend in the economy, jobs for these accounting professionals will not be affected due to the fact that even in a negative environment, industry has to generate and maintain books of accounts. Out of two million clerks engaged in book-keeping services in the U.S. one third of them is in wholesale and retail sector, one fourth in social, educational, health and services sectors and remaining as part-timers though they are vulnerable to computerization in the offices. Average annual salary which was $ 17,000 in 1990s for junior accountants to start with, now ranges from $ 26,000 to $ 33,750 depending on their bachelors or masters qualifications. Managers and directors with five to eight years of experience in accounting firms earn $ 56,250 to $ 92,000 depending on the size of the firms. After eight to twelve years, an accountant is elevated to partner status and paid $175,000 as a first year salary. (Robert 1999) Demand for qualified accountants is ever growing from the early 2000s and for most of the aspiring professionals’ target accountings firms are the big four who offer flexible working hours and democratic promotion system.( Demery Paul March 1996) According to Tami Kegley, CPAs should focus their attention towards the international market, technological applications and strategic knowledge management.( Kegley Tami 1998). “Because the American way of doing business exerted a powerful influence on the rest of the world throughout the twentieth century, and because American accounting standards, building on British precedent and developed over the course of that century, had established a level of sophistication and authority recognized around the world, international accounting standards greatly conform to an American model.”(SIC 8721) Conclusion Though the US is yet to comply with the above IFRS, it has already engaged itself in several projects of convergence of US GAAP with IFRS. It is expected that soon IFRS will also be adopted in the US and there will be uniform accounting standards not only for facilitating domestic capital market transactions but also for international capital transactions. This along with implementation of Sarbanes-Oxley Act will surely usher in a new era of mature accounting standards and auditors to serve as watch dogs for the investing public in the 21st century. REFERENCES Brickey F. Kathleen Washington University Law Quarterly vol 81.357 ‘from Enron to Worldcom and Beyond: Life and Crime After Sarbanes-Oxley’ Carey L John, The Rise of the Accounting Profession (New York: American Institute of Certified Public Accountants, 1969), I, 32., 157, 5-86 Chatfield Michael 1968, Contemporary Studies in the Evolution of Accounting Thoughts (Belmont, California: Dickenson, 1968), 137. Chatfield Michael, A History of Accounting Thought (Illinois: Dryden, 1974), 112, 117, 118. Demery, Paul. "The Changing Demographics of Accounting Firms." The Practical Accountant, March 1996. DeRidder J Jerome, Economic and Business Historical Society, Whitten O David, EBHS Archivist , The United States Auditing Profession Past, Present and Future Kegley, Tami. "Solutions: From Auditors to Consultants—the Changing Roles of CPAs." AccountingNet, 7 September 1998. Leeds Estate Building and Investment Company v Shepard (1887). Orrick 2002 Securities Law Update August 2002 Robert 1999 Robert Half and Accountemps Salary Guide SIC 8721 Accounting, auditing, and bookkeeping services , Thomson Gale accessed on May 15,2007 Zeff Stephen , Forging Accounting Principles in Five Countries (Champaign, Illinois: Stipes, 1972), 110. Read More
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