Effect of Accounting Impropriety and Enron Scandal - Assignment Example

? Finance and Accounting: Discussions Discussion Enron Scandal Enron Corporation was the largest natural gas dealer in North America. Enron’s stock prices rose by 311% over the 1990-98 period and on the strength of this great growth rate, the Fortune’s Most Admired Company survey chose Enron as the most innovative large company. However, the Enron’s indecipherable business nature and vague accounting practices caused stock price falls, SEC investigation, and credit rating downgrade. Later on reports came out that Jeffrey Skilling, the former CEO of the company, had managed to create an illusionary financial status for the company through accounting loopholes, unsupported financial reporting practices, and special purpose entities. The Enron fraud was revealed to the public in October 2001 and this ended up in the bankruptcy of the organization. While analyzing the Enron accounting impropriety, it appears that the company executives exploited accounting limitations with intend to create a false view of the cash flows and to prepare a misleading balance sheet. This inflated the profits. Fair accounting practices and proper annual reporting might have prevented the Enron scandal. Effect of Accounting Impropriety Although improper or illegal accounting practices may assist a firm to gain short term financial benefits, such practices can have dreadful consequences on the company in the long term. Undoubtedly, accounting malpractices will reduce stakeholder confidence in management and hence investors would be reluctant to invest in the company. This situation may adversely affect the firm’s overall financial performance. Management professionals opine that active stakeholder engagement in business is inevitable to improve financial performance. Hence, in order to minimize the resulting impact of accounting impropriety on the business, making timely changes to the top management team and to publish proper annual reports is essential. Discussion 2 Bookkeeping and Accounting The statement ‘bookkeeping and accounting are the same’ flaws. Bookkeeping can be simply defined as the process of recording a business entity’s day to day transactions in chronological order whereas accounting refers to the art of recording, classifying, summarizing, analyzing, interpreting, and reporting. Hence, it can be stated that bookkeeping constitutes the basic part or starting point of the accounting process. As Banerjee (2010) states, the scope of bookkeeping is restricted to systematic and repetitive recording of business transactions in ledger accounts through journal. In contrast, the accounting process involves the preparation of Trial Balance, Profit & Loss A/c, Income Statement, and Balance Sheet using accepted accounting principles. While bookkeeping is only a clerical job, accounting is an analytical job (p.4). Accounting Equation Accounting equation also referred to as balance sheet equation, reflects the relationship between assets, liabilities, and owner’s equity of a business. This equation is linked to the concept that total debits equal total credits. The accounting equation can be expressed as Assets = Liabilities + Capital. As accounting equation is fundamental to the double entry bookkeeping system, it can greatly support the work of professional accountants. More precisely, this equation is the basic idea behind the preparation of balance sheet. A good understanding of this equation can assist stakeholders, particularly investors to form potential business decisions. While making business decisions, it is important to give specific focus to liabilities rather than assets. Discussion 3 SOX and Accounting Professionals The Sarbanes-Oxley Act (SOX) has been recently introduced in the United States to promote fair reporting of asset valuation. The SOX framework necessitates proper financial accounting disclosure and therefore organizations are required to produce complete information of assets, depreciation, values, and status in any accounting period (Omnix Asset Management, n.d). As the SOX has precise standards for accounting practices, it is easy for accounting professional to effectively comply with legal accounting standards to successfully defend future lawsuits claiming damages. Furthermore, it gives a systematic framework for accounting practitioners, and hence they can easily complete their work within the stipulated time period. “SOX has created an opportunity to provide tax services to corporations that need to divvy up work among various firms” (Accounting web, June 6, 2005). SOX and Investors Section 401 of the SOX framework has set provisions for certain procedures that can make certain accurate disclosures in periodic reports. These accounting procedures prevent companies from inflating or deflating profits and thereby check fictitious financial reporting practices. According to the Section 802 of the Sarbanes-Oxley Act (as cited in Legal Information Institute), the violation of SOX standards is considered to be a criminal offence and therefore the defendant shall be fined or/and imprisoned. It puts a moral check on accounts and auditors and persuades them to act in strict compliance with the SOX framework. Evidently, this situation is helpful to ensure a true and fair view of the state of affairs of the company. This in turn would reinforce creditors’ and investors’ confidence in the firm. Discussion 4 Treatment of Environmental Costs For the Chief Financial Officer (CFO), it is better to state costs related with pollution, environmental-disposal, or demolition problems in the in the ‘expenses’ column of the income statement. The CFO may also add this item on the asset side of the balance sheet because environmental spending adds value to the goodwill of the organization. Today many companies prepare separate sustainability reports also along with their financial statements to demonstrate their environmental responsibility. The top management is likely to discourage this proposal as it is not a common practice in financial reporting. However, the management’s resistance to change can be overcome by citing the fact that this practice would contribute to the firm’s goodwill. Advantages and Disadvantages One of the notable disadvantages of recording environmental costs in the financial statements is that it increases accounting complexity. Hence, this practice may cause to delay the preparation of financial statements by the end of the accounting period. Despite these minor drawbacks, this financial reporting practice is very effective to improve the public image as well as brand loyalty of the organization. Today people are increasingly concerned about environmental sustainability. Hence companies allot a portion of their revenues for environmental protection with intent to gain high market reputation. At this juncture, the practice of recording environmental costs in financial statements would assist firms to communicate their environmental responsibility directly to stakeholders. Undoubtedly, this practice can improve the firm’s public image, which in turn would attract potential investors and thereby promote business growth. References Accounting web. (June 6, 2005). Smaller Accounting Firms Reap Benefits from SOX. Retrieved from http://www.accountingweb.com/topic/cfo/smaller-accounting-firms-reap-benefits-sox Banerjee, B. K. (2010). Financial Accounting : Concepts, Analyses, Methods And Uses. PHI Learning Pvt. Ltd. Legal Information Institute. 18 USC § 1519 - Destruction, alteration, or falsification of records in Federal investigations and bankruptcy. Cornell University. Retrieved from http://www.law.cornell.edu/uscode/text/18/1519 Omnix Asset Management. Retrieved from http://www.avw.co.nz/catalogue/images/andrew/docs/BR-100682-EN.pdf Read More