Effect of Unethical Behavior in Accounting

When describing accounting, it can be defined, as a type of method used to provide information with regards to the financial position of a company or an organization. The information provided to investors is imperative because it provides the investor with valuable information that can lead to their determination as to whether they should decide to invest or not to invest in a specific organization. Consequently, because of unethical practices and behaviors in accounting it is unusual to find such unethical behaviors. Some unethical practices in accounting that can be found would be to have misleading financial analysis for personal gain, exaggeration of revenue, and providing erroneous information pertaining to the company’s expenses and liabilities, misuse of funds, or exaggerating the value of corporate assets. In addition, to these unethical behavior there are other unethical practices like insider trading, bribery, securities fraud, and manipulation of the financial markets. In the late 1990’s and early 2000’s both publicly traded companies, WorldCom and Enron added weighted truth to the credibility of accounting and business ethics.

Both Companies were involved in scandals that engaged in misrepresentation in financial statements and fraud. Enron was one of the world’s leading American energy company’s and in October 2001 Enron Corporation filed bankruptcy, this was due to the unethical behavior that Enron executives had practice. Enron had used ambiguous accounting methods. They provided false financial reports to conceal the billions of dollars in debt they acquired from unsuccessful business projects. The fraudulent actions taken by the Enron executives deceived the board of directors, shareholders, who lost billions when the stock prices dropped, and the audit committee of Arthur Andersen who they had overlook the financial concerns of the company; this cause the collapse of Arthur Andersen Partnership as well. WorldCom also filed bankruptcy for fraudulent accounting practices that consisted of enhancing revenue amounts with fictitious accounting entries. Because of the magnitude of these unethical accounting behaviors, this caused the US government to become involve and create the Sarbanes-Oxley Act of 2002.

The intent of this act was to prevent unethical behavior by setting rules for auditors in accounting and their clients. In the article by (Jelinek, 2010), Becoming a More Relational Firm in the Post-Sarbanes-Oxley Era, The effects of the SOX Act are: 201: Prohibited auditor activities – Forbids a company’s audit firm from cross-selling to the company eight specific nonaudit services (including “consulting” services). 203: Audit Partner Rotation – Requires both the lead partner and the reviewing partner of the audit firm to rotate off the company’s audit every five years. 204: Auditor Reports to Audit Committees – Mandates the auditor report directly to the company’s audit committee on particular aspects of the audit. 206: Conflicts of Interest – Prohibits ex-employees of the accounting firm from taking “key positions” at the client company (e.g. CEO, CFO, chief accounting officer, controller) for up to a year before the audit. 301: Public Company Audit Committees – Requires the company’s audit committee( as opposed to the company itself) to 1) determine which accounting firm to hire to perform audit work, 2) approve the audit services provided by the audit firm and oversee such work, and 3) compensate the firm for performing audit work.

In addition, all committee members must be independent of the client company. 407: Disclosure of Audit Committee Financial Expert- Requires public companies to disclose when at least one member of the audit committee is a “financial expert”. To prevent organizations from conducting unethical accounting practices such as Enron and WorldCom, companies must implement changes to improve professional ethics. This can be done by having senior management show strong ethical behavior and leadership and prevent such behavior to occur. The 406 section of SOX is intended to promote honest and ethical conduct: To disclose reliable and accurate reports and in addition, to abide with government rules and regulations.

References

Jelinek, R. & Jelinek, K. (2010), Becoming a more relational firm in the Post-Sarbanes- Oxley era. The CPA Journal, 80(9), 64.