In: Accounting
Background: Accounting scandals and fraud, both in the United States and internationally, have re-ignited the debate over the current laws, regulation and accounting principles. The relative merits of GAAP, which takes a “rules-based” approach to accounting, versus IFRS, which takes a “principles-based” approach have been under scrutiny. In the last couple of years, the FASB announced that it intends to introduce more principles-based standards to improve general accounting principles and practices.
Organizations have internal control measures to detect fraud. In additions, organizations are subjected to required reporting of financial information to external entities. With that in mind, answer the following items in your initial discussion response:
Make sure your initial response contains 175- to 265-words.
APA Formatting: Use citations where appropriate and list references.
FRAUD also known as Deception, Double-Dealing, Subterfuge, Trickery , which means an act or practices of one who deliberately deceives. It is cheating or merely tactical resource. Fraud in our context here is more implying about ACCOUNTING / FINANCIAL FRAUD relating to accounting principles or rules. Accounting Fraud is defined as the intentional manipulation of financial records or statements. Companies usually commit accounting fraud to make it appear that their business's financial health is better than really it is. This can also be said as WINDOW DRESSING in auditing terms. Furthermore, it involves an employee , accountant or organization itself misleading investors and shareholders. Thus accounting fraud is the illegal alteration of a company's financial statements in order to manipulate a company's apparent health or to hide profits or losses.
Following factors can contribute to such frauds:
1) OVERSTATING REVENUE
2) UNRECORDED EXPENSES
3)MISSTATING ASSETS AND LIABILITIES , let's understand each of these in detail.
1) Overstating Revenue : let's understand this with an example, suppose company XYZ Ltd is incurring losses and its difficult to bring the situation back with revenues. Thus to dress up this situation , the firm might claim to be producing more income o financial statments than it does in reality. On its statements , the company's profits would be inflated. If the company overstates its revenue , it would drive up the firm's share price and create a false image of financial health. Thus a company can commit acoounting fraud by overstating its revenue.
2) Unrecorded Expenses : This type of accounting fraud creates a false impression of how much net income a company is receiving. In reality it may be losing money. This is generally done by overstating company's net income and understating its costs on the income statement.
3) Misstating assets and liabilities : Such type of accounting fraud occurs when a company overstates its assets or understates its liabilities. For example, a company might overstate its current assets and understates its current liabilities therey misrepresenting a company's short term liquidity. Let's take an example, suppose a company has current assets of $3 million and its current liabilities are $5million . If a company overstates its current assets and understates its current liabilities , it might misrepresent its liquidity. The company could state that it has $7million current assets and $3million current liabilities. Then potential investors will tend to believe that the company has enough liquid assets to cover up all of its liabilities.
Some of the Strategies to prevent such Financial Fraud :
Prevention is the best way for companies to avoid the negative hassles and costly losses of accounting fraud. Its advised that businesses establish anonymous reporting systems where honest employees can give tips on red flags.Implementing internal auditing controls is important to quickly detect fraud and keep financial records accurate. Hiring a team of Certified Internal Auditors (CIA's) or Certified Fraud Examiners (CEF's) can help with creating an anti-fraud work environment. Other great practices used to stop accounting fraud include using a system of checks and balances., reconciling bank accounts monthly, restricting use of business credit cards and conducting unannounced cash accounts. Small and medium sized firms are more vulnerable to fraud thus some of the measures which can be taken by them are : Segregating accounting duties, Knowing employees, maintaining internal controls, scrutinizing business bank accounts, auditing the books on regular basis, training employees to prevent such fraud, protecting credit card information, knowing business partners and getting expert help.
ENRON SCANDAL involved one of the biggest bankruptcy filings in the history of US which held more than $60 billion in assets. It resulted in the bankruptcy of the US enery, commodities and services. It generated much debate as well as legislation designed to improve accounting standards and practices with long lasting repercussions in the financial world. Enron was founded in 1985 by Kenneth Lay in the merger of two natural gas transmission companies, Houstan Natural Gas Corporation and InterNorth, Inc; the merged company HNG Internorth was renamed Enron in 1986. After the US Congress adopted a series of laws to deregulate the sale of natural gas in the early 1990s, the company lost its exclusive rights to operate its pipelines. With the help of Jeffrey Skilling, who was initially a consultant and later became the company's Chief Operating Officier, Enron transferred itself into a trader of energy derivatives contracts, acting as an intermediary between natural gas producers and their customers. The traders allowed the producers to mitigate the risk of energy price fluctuations by fixing the selling price of their products through a contarct negotiated by Enron for a fee. Under Skilling's leadership , Enron soon dominated the market for natural gas contracts and the company started to generate huge profits on its trades. Skilling also gradually changed the culture of the company to emphasize aggresive trading. He hired top candidates from MBA programs arounf the country and created an intensely competitive environment within the company, in which the focus was increasingly on closing as many cash generating trades as possible in the shortest amount of time. One of the brightest recruits was Andrew Faston who quickly rose through the ranks to become Enron's CFO. Fastow oversaw the financing of the company through investments in increasingly complex instruments, while Skilling oversaw the building of its vast trading operation. The bull market of the 1990s helped to fuel Enron's ambitions and contributed to its rapid growth. There were deals to be made everywhere and the company was ready to create a market for anything that anyone was willing to trade. It thus traded derivative contracts for a wide variety of commodities- including electricity, coal, paper and steel and even for the waether. An online trading division, Enron Online, was launched during the dot-com boom and the company invested in buliding a broadband telecommunications network to facilitate high speed trading.
As the boom years came to an end and Enron faced increased competiton in the energy trading business, the company's profits sharnk rapidly. Under pressure from shareholders, the company executives began to rely on dubious accounting practices, including a techinique known as " mark-to-market accounting", to hide the troubles. Mark-to-market accounting allowed the company to write unrealized future gains from some trading contracts into current income statements, thus giving the illusion of higher current profits. Furthermore, the troubled operations of the company were transferred to so-called special purpose entities( SPEs), which are essentially limited partnerships created with outside companies distributed assets to SPEs, Enron abused the practice by using SPEs as dump sites for its troubled assets. Transferring those assets to SPEs meant that they were kept off Enron's books, making its losses look less severe than they really were. Ironically some of the SPEs were run by Fastow himslef. Thorughout these years; Arthur Anderson served not only as Enron's Auditor but also as a consultant for the company.
The severity of the situation began to become apparent in the mid-2001 as a number of analysts began to dig into the details of Enron's publicly released financial statements. An internal investigation was initiated following a memorandum from a company vice president and soon the Securities and Exchange Commision (SEC) was investigating the transactions between Enron and Fastow's SPEs. As the details of the accounting frauds emerged , the stock price of the company plummered from a high of $90 per share in the mid-2000 to less than $1 by the end of November 2001, taking with it the value of Enron employees' 401(k) pensions, which were mainly tied to the company stock. Lay and Skilling resigned and Fastow was fired two days after the SEC investigation started. On December 2, 2001, Enron filed for Chapter 11 bankruptcy protection. Many Enron executives were indicated on a variety of charges and were later sentenced to prison. Arthur Andersen came under intense scrutiny and eventually lost a majority of ts clients. The damage to its reputation was so severe that it was forced to dissolve itself. In addition to federal lawsuits, hundreds of civil suits were filed by shareholders against both Enron and Andersen.
The Scandal resulted in a wave of new regulations and legislations designed to increase the accuracy of financial reporting for publicy traded companies.