Accounting scandals are business scandals which arise from intentional manipulation of financial statements with the disclosure of financial misdeeds by trusted executives of corporations or governments.
Such misdeeds typically involve complex methods for misusing or misdirecting funds, overstating revenues , understating expenses, overstating  the value of corporate assets or underreporting the existence of liabilities. It involves an employee, account or corporation itself and is misleading to investor and shareholders.
This type of " creative accounting " can amount to fraud , and investigations are typically launched by government oversight agencies, such as the Securities and Exchange Commission SEC in the United States. Employees who commit accounting fraud at the request of their employers are subject to personal criminal prosecution.
Misappropriation of assets, often called defalcation or employee fraud, occurs when an employee steals company's asset, whether those assets are of monetary or physical nature. Typically, assets stolen are cash or cash equivalents and company data or intellectual property. Company assets include everything from office supplies, inventory to intellectual property. Fraudulent financial reporting, also known as earnings management fraud. In this context, management intentionally manipulates accounting policies or accounting estimates to improve financial statements.
Public and private corporations commit fraudulent financial reporting to secure investor interest or obtain bank approvals for financing, as justifications for bonuses or increased salaries or to meet expectations of shareholders.
The fraud triangle is a model for explaining the factors that cause someone to commit fraudulent behaviors in accounting. It consists of three components, which together, lead to fraudulent behavior:. A common incentive for companies to manipulate financial statement is a decline in the company's financial prospects. Companies may also manipulate earnings to meet analysts' forecasts or benchmarks such as prior year earnings, to meet debt covenant restrictions, to achieve a bonus target based on earnings, or to artificially inflate stock prices.
As for misappropriation of assets , financial pressures are a common incentive for employees. Employees with excessive financial obligations, or those with drug abuse or gambling problems may steal to meet their personal needs. Although the financial statements of all companies are potentially subject to manipulation, the risk is greater for companies in industries where significant judgments and accounting estimates are involved. Turnover in accounting personnel or other deficiencies in accounting and information processes can create an opportunity for misstatement.
As for misappropriation of assets, opportunities are greater in companies with accessible cash or with inventory or other valuable assets, especially if the assets are small or easily removed.
A lack of controls over payments to vendors or payroll systems, can allow employees to create fictitious vendors or employees and bill the company for services or time. The attitude of top management toward financial reporting is a critical risk factor in assessing the likelihood of fraudulent financial statements. If the CEO or other top managers display a significant disregard for the financial reporting process, such as consistently issuing overly optimistic forecasts, or they are overly concerned about the meeting analysts' earnings forecast, fraudulent financial reporting is more likely.
Similarly, for misappropriation of assets, if management cheats customers through overcharging for goods or engaging in high-pressure sales tactics, employees may feel that it is acceptable for them to behave in the same fashion.
A weak internal control is an opportunity for fraudster. Poor management information where a company's management system does not produce results that are timely, accurate, sufficiently detailed and relevant. In such case, the warning signal of fraud such as ongoing theft from bank account can be obscured.
Lack of an independent audit department within the company is also a sign of weak internal control. An example of poor accounting practice is failure to make monthly reconciliation of bank account. The executive can accelerate accounting of expected expenses, delay accounting of expected revenue, engage in off balance sheet transactions to make the company's profitability appear temporarily poorer, or simply promote and report severely conservative e.
Such seemingly adverse earnings news will be likely to at least temporarily reduce share price. This is again due to information asymmetries since it is more common for top executives to do everything they can to window dress their company's earnings forecasts. Top managers tend to share price to make a company an easier takeover target. When the company gets bought out or taken private — at a dramatically lower price — the takeover artist gains a windfall from the former top executive's actions to surreptitiously reduce share price.
This can represent tens of billions of dollars questionably transferred from previous shareholders to the takeover artist. The former top executive is then rewarded with a golden handshake for presiding over the firesale that can sometimes be in the hundreds of millions of dollars for one or two years of work. Similar issues occur when a publicly held asset or non-profit organization undergoes privatization. Top executives often reap tremendous monetary benefits when a government-owned or non-profit entity is sold to private hands.
Just as in the example above, they can facilitate this process by making the entity appear to be in financial crisis — this reduces the sale price to the profit of the purchaser , and makes non-profits and governments more likely to sell. It can also contribute to a public perception that private entities are more efficiently run, thereby reinforcing the political will to sell off public assets.
Again, due to asymmetric information , policy makers and the general public see a government-owned firm that was a financial 'disaster' — miraculously turned around by the private sector and typically resold within a few years. Not all accounting scandals are caused by top executives. Often managers and employees are pressured or willingly alter financial statements for the personal benefit of the individuals over the company.
Managerial opportunism plays a large role in these scandals. For example, managers who would be compensated more for short-term results would report inaccurate information, since short-term benefits outweigh the long-term ones such as pension obligations. The Enron scandal turned in the indictment and criminal conviction of one of the Big Five auditor Arthur Andersen on June 15, Although the conviction was overturned on May 31, , by the Supreme Court of the United States , the firm ceased performing audits and is currently unwinding its business operations.
The Enron scandal was defined as being one of the biggest audit failures. For auditing a big sized company such as Enron, the auditors were criticized for having brief meetings a few times a year that covered large amounts of material. By January 17, , Enron decided to discontinue its business with Arthur Andersen claiming they had failed in accounting advice and related documents.
Arthur Andersen was judged guilty of obstruction of justice for getting rid of many emails and documents that were related to auditing Enron. Since the SEC is not allowed to accept audits from convicted felons, the firm was forced to give up its CPA licenses later in , costing over , employees their jobs.
Although later the ruling was overturned by the U. Supreme Court , the once-proud firm's image was tarnished beyond repair, and it has not returned as a viable business even on a limited scale. On July 9, George W.
Bush gave a speech about recent accounting scandals that had been uncovered. In spite of its stern tone, the speech did not focus on establishing new policy, but instead focused on actually enforcing current laws, which include holding CEOs and directors personally responsible for accountancy fraud.
In July , WorldCom filed for bankruptcy protection, in what was considered the largest corporate insolvency ever at the time. The Financial Accounting Standards Board announced that it intends to introduce more principles-based standards. More radical means of accounting reform have been proposed, but so far have very little support.
The debate itself, however, overlooks the difficulties of classifying any system of knowledge, including accounting, as rules-based or principles-based. This also led to the establishment of Sarbanes-Oxley. On a lighter note, the Ig Nobel Prize in Economics went to the CEOs of those companies involved in the corporate accounting scandals of that year for "adapting the mathematical concept of imaginary numbers for use in the business world".
In , Nortel made a big contribution to this list of scandals by incorrectly reporting a one cent per share earnings directly after their massive layoff period. They used this money to pay the top 43 managers of the company.
Dunn , Douglas C. Gollogly and MaryAnne E. These proceedings have been postponed pending criminal proceedings in Canada, which opened in Toronto on January 12, In , after a scandal on insurance and mutual funds the year before, AIG was investigated for accounting fraud.
The company already lost over 45 billion US dollars' worth of market capitalisation because of the scandal. Investigations also discovered over a billion US dollars' worth of errors in accounting transactions. Well before Bernard Madoff 's massive Ponzi scheme came to light, observers doubted whether his listed accounting firm—an unknown two-person firm in a rural area north of New York City —was competent to service a multimillion-dollar operation, especially since it had only one active accountant.
Friehling , admitted to simply rubber-stamping 18 years' worth of Madoff's filings with the SEC. He also revealed that he continued to audit Madoff even though he had invested a substantial amount of money with him. Accountants aren't allowed to audit broker-dealers with whom they're investing.
His involvement makes the Madoff scheme the largest accounting fraud in world history. From Wikipedia, the free encyclopedia. The neutrality of this section is disputed.
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