Question

How do you feel that Enron and Worldcom scandals impact investor trust and the accounting profession?

Answer 1

The Enron and Worldcom scandal are the first and still one of the biggest accounting frauds of all time. These scandals brought attention of the entire world to reliability and faithfulness of the financial reports of the companies. The cases have been scrutinized by analysts and professionals to assess what led to these scandals being unrecognized for many years. These scandals have changed the approach of accounting bodies to formulating and implementing accounting standards. These also led to downfall in the trust of investors on the management and accounting professionals.

Enron filed for bankruptcy in October 2001. The company was using accounting limitation to paint a rosy picture of the company's revenues and profits in the financial statements. The company was using merchant model for revenue recognition which led to inflation in the revenues of the company. It also used Mark-to-market accounting i.e. valuing assets on market prices which were found to be heavily inflated. Despite the fact that company was manipulating its revenues and profits and was deploying unethical industry practices, the auditors of the company failed to report these to the investors. Arthur Anderson, the auditors as well as consultants of the company, were negligent in there auditing practices and were facing conflict of interest as the firm has a significant revenues from Enron.

In case of Worldcom, the company reported its expenses as capital investment and has inflated its reserves to show a good profitability to the investors. The company released in 2002 that it has been doing wrong accounting since 1999. The company disclosed that it would release revised financial statements after correcting the errors. The auditors of the company were Arthur Anderson who were the already under scrutiny for professional practices for Enron and other companies. After audit and restatement of financial statements, the company reported losses.

The Enron and Worldcom scandal led to bankruptcy of these two companies and dissolution of one of Big 5 firms, Arthur Anderson. The scandals caused serious mistrust in the investors and other stakeholders on the financial reporting and auditing practices adopted by the companies. Two companies which were one of the biggest companies, were practicing accounting frauds without being noticed by accounting professionals as well as their external auditors. It pointed out that the auditor's independence is a key factors which should be kept in mind while appointment. The Enron scandal make the accounting and auditing standard boards to make strict norms for auditors. The Enron scandal led to formulation of Sarbanes Oxley Act 2002. The act is also known as the Public Accounting Reform and Investors Protection Act which was aimed to punish the defaulters while protect the interest of the investors. The act includes clauses for extensive responsibilities of management, additional disclosures requirements, audit reforms and criminal punishments for corporate frauds. The act was aimed to mitigate the loss of trust in audit process and integrity of accounting professionals.

It can be stated that the Enron and Worldcom scandal have caused loss of investors' trust in financial reports and audit process. However, these cases have led to formulation of stringent norms for financial reporting, auditing process, disclosures to enhance the transparency and reliability of financial statements. The corporate governance includes principles for appointment of independent directors in board and in audit committee to ensure that the decision are taken in the interest of the stakeholders and to monitor the implementation of accounting standards and internal controls in the business. There are regulations made for audit engagement including quantum of audit fees and limitation on external auditors to provide other consulting services to the auditee entity.

In conclusion, the scandals affected the accounting profession as we know it today. The accounting and auditing boards have taken steps to rebuild the trust of investors in the profession.