Contemporary issues in accounting

Accounting practices has dramatically changed within the past few years because of the calamitous undertakings of some of the world's most prestigious companies. Loopholes within accounting regulations and the general greed of American corporations have led to significant issues in accounting practice. Most prominent among these issues has arisen the case of Enron, the biggest financial and accounting blunder of the past mellenium. Perhaps the most shocking aspect of the Enron scandal is the depth of deception and the complex methods used to exploit accounting weaknesses. Therefore this detailed analysis will look into how Enron's failure attributed to the exploitation of accounting practices and how accounting has changed because of the specific policies applied to Enron.

It took only months for the collapse of one of the world's greatest corporations. Enron was highly regarded, a mere two months before its collapse as one of the world's greatest innovators, with its focus on developing cutting edge technology and increase growth in every sector. With its collapse, an entire nation was devastated by its financial implications especially on numerous 401K accounts. Yet no one was able to raise an alarm until it was too late, the reason for the lack of anticipation is a massive failure within the accounting system to keep reliable records of the firm's actual condition.

The accounting techniques used within the Enron scandal were very complex and hard to catch, they involved two very hard to detect relationships, unconsolidated partnerships and the formation of "special purpose entities." Using these two methodology, they were able to prevent significant revenue loss from appearing in their financial records as well as conceal the existence of any debt the company procured. It was when these results actually came to the forefront that the world soon realized that most of the earnings that the company claimed in the past two years were completely falsified.

The first major accounting blunder comes from the ineffectiveness of the current U.S. auditing methodology. The SEC regulations state that public corporations need to have their finances certified by an independent auditor. However, since there are little to no regulation on the auditing process nor any control mechanisms to prevent collusion, Enron was able to employ an individual like Arthur Anderson who willingly lied and cheated with his co-conspirators. Previously, oversight of all auditing practices and auditors have lied with the American Institute of Certified Public Accountants which is a non-government trade group as well as independent state boards. However, this is clearly not stringent enough as Enron was not an isolated incident (both World Com and Tyco had similar problems), therefore the SEC and the current administration have used several different methodologies to prevent future exploitation. The creation of a new auditor oversight authority linked to the SEC is the latest trend, and this is especially necessary in light of the decentralized regulation within this sector. However, all of these was trumped by the passage of the Sarbanes-Oxley bill, which will forever change the face of auditing practices. This new bill ensures that public companies will have their financials records audited twice and have placed stringent new laws to prevent the accounting exploitations that Enron and other companies used to hide their financial position from investors.

Major issues that the Enron crisis brought to light include the existence of SPEs. Up until this point, special purpose entities created by a company does not have to be consolidated along with the statements of its parent company. This means that as long as these SPEs have, "As little as 3% of the capital invested from an independent third party, it does not have to consolidate its corporate financial statements" (CRS report for Congress, npg). Enron exploited this loophole to its fullest advantage. By effectively using the relationships established between SPEs and themselves, they were able to leverage these entities to write off existing debt as well as "re-buy" goods from their own company. The result was that the books always balanced, but still did not reveal the extent of the damage done to the company. SPE law has since been dramatically mitigated by Sarbanes-Oxley, this is partially due to the much stricter regulation of the auditing procedure. However, the application of the 3% independent ownership has been restructured to make SPEs much clearer to delineate between parent company ownership and independent ownership.

Another major issue that arose out of the Enron scandal is the manipulation used by Anderson of derivatives. In a BBC report, Emma Clark explains, "If you dig deep enough into any financial scandal you can usually find a derivative or two to take the blame" (Callahan, npg). Derivatives are in fact financial products that derive their value from any underlying assets that a company might have. Enron, much like other companies used derivative trading in order to fully engage its business and reduce its business risks. Although it was actually profitable within its derivative trading, the accounting practices involved in calculating these profits allowed them to disguise heavy losses in its business sectors attributed to derivatives trading. Enron's case was especially severe "their dubious maneuvers involving derivatives were desgined to enhance the company's "accounting reality" at the expense of its true economic condition" (Callahan, npg). Therefore in the wake of these exploitations, the government has attempted to create many lega barriers to protect the investment of the general public. Regulations now encourage publicly traded companies to place more focus in the protection of their core financial practices rather than seek greater profits through diversification and derivative trading.

Another major issue in the Enron debacle was the lack of disclosure that was involved in the entirety of the accounting procedure. Under the auditing and accounting regulations of the time, Enron had no responsibility to disclose its financial documents for closer inspection to anyone other than its independent auditor. As a result, its claims could not be properly examined by others and thus were viewed as financially sound. This is especially true for financial arrangements that are made internally that involve "contingent liabilities." With greater disclosure in general, the loopholes of SPEs exploited by Enron would be instantly recognized and would be very hard to execute for the corporate party. The Financial Accounting Standards Board has placed greater emphasis on the use of uniform accounting standards in combination with the SEC to secure greater disclosure of governmental practices across the board.