Accounting Scandals

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Definition: Accounting Scandals


Accounting Scandals

Quick Summary of Accounting Scandals


Accounting Scandals are instances when corporations have been found responsible for serious breaches of Accounting Ethics.



Video Guide For Accounting Scandals




Full Definition of Accounting Scandals


Accounting scandals or corporate accounting scandals are political and business scandals that arise with the disclosure of misdeeds by trusted executives of large public corporations. 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, sometimes with the cooperation of officials in other corporations or affiliates.

In public companies, 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.

In 2002, a wave of separate but often related accounting scandals became known to the public in the U.S. All of the leading public accounting firms—Arthur Andersen, Deloitte & Touche, Ernst & Young, KPMG, PricewaterhouseCoopers— and others have admitted to or have been charged with negligence in the execution of their duty as auditors to identify and prevent the publication of falsified financial reports by their corporate clients which had the effect of giving a misleading impression of their client companies’ financial status. In several cases, the monetary amounts of the fraud involved are in the billions of USD.

Often, this involves deceptive adjustments to their balance sheets or profit and loss accounts – using methods such as:

  • Hiding expenses.
  • Inflating revenue.
  • Moving debts off-balance-sheet.
  • Manipulating reserves.

Whilst Senior Executives have on occasion used such means for private gain, the objective more often than not is to create a false impression of Corporate success in order to meet the expectations of the financial markets.

One of the most notorious examples of accounting scandals in recent times is the Enrol scandal of 2001, this particular example effectively demonstrates the devastating impact of both false accounting and failures in auditing.

The Enron scandal resulted in the indictment and criminal conviction of the Big Five auditor Arthur Andersen on June 15, 2002. Although the conviction was overturned on May 31, 2005 by the Supreme Court of the United States, the firm ceased performing audits and is currently unwinding its business operations.

There was a general perception that there are other accountancy scandals waiting to be uncovered, which contributed to the stock market downturn of 2002.

On July 9, 2002, George W. Bush gave a speech about recent accounting scandals that have 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 2002, WorldCom filed for bankruptcy protection, in the largest corporate insolvency ever.

These scandals reignited the debate over the relative merits of US GAAP, which takes a “rules-based” approach to accounting, versus International Accounting Standards and UK GAAP, which takes a “principles-based” approach. 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.

In 2005, after a scandal on insurance and mutual funds the year before, AIG is under investigation for accounting fraud. The company already lost over 45 billion US dollars worth of market capitalisation because of the scandal. This was the fastest decrease since the WorldCom and Enron scandals. Investigations also discovered over a billion US dollars worth of errors in accounting transactions. The future outcome for the company is still pending.

On a lighter note, the 2002 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”.

Here’s a better look at three of the biggest accounting scandals in recent history.

Enron

Established in 1985, Enron was one of the world’s largest traders of natural gas. As the company expanded, Enron aggressively assumed new debt. To conceal these growing obligations, Enron used special purpose entities, or variable interest entities, to keep the debts off their balance sheet. They also used accounting gimmicks to inflate their profits by more than $1 billion.

Arthur Andersen, one of the largest public accounting firms in the world at the time, audited the books for Enron. After allegedly assisting in the hiding of debts and inflation of profits, including shredding documents related to its audit of Enron, Arthur Andersen was found guilty of obstructing justice and was forced to close its doors.

After a formal investigation by the Securities and Exchange Commission (SEC) in 2001, Enron filed for Chapter 11 bankruptcy and laid off 4000 employees.

WorldCom

WorldCom was founded in 1983 and quickly became the second-largest long-distance phone company in the United States. From 1999 to 2002, WorldCom committed major accounting fraud in preparing its balance sheet.

By inflating their revenues and capitalizing rather than expensing their line costs, they falsely increased the price of WorldCom’s stock. CEO Bernie Ebbers was highly involved in the scandal and convinced the board of directors to authorize hundreds of millions of dollars in personal loans from the company, which ultimately cost investors $180 million.

In June 2002, WorldCom’s internal auditors discovered $3.8 billion in fraudulent accounting entries. A formal investigation determined that WorldCom’s assets were actually inflated by $11 billion. In 2002, WorldCom filed for the largest Chapter 11 bankruptcy in U.S. history.

After emerging from bankruptcy in 2004 with $5.7 billion in debt, WorldCom is still trying to pay its creditors. In 2005, WorldCom’s ex-CEO Bernard Ebbers was convicted of fraud, conspiracy, and filing false documents with regulators. He was sentenced to 25 years in prison.

Bernie Madoff

As the mastermind of the first global Ponzi scheme in history, Bernie Madoff was responsible for an estimated $50 billion loss in personal and institutional wealth. Madoff attracted potential investors with promises of high returns, which he paid out with new investors’ money rather than actual profits. His Ponzi scheme was successful until tough economic times caused investors to withdraw funds, draining his cash reserves.

After being turned in by his two sons in December 2008, Madoff plead guilty to eleven charges, including fraud, international money laundering, and lying to federal securities regulators. In June 2009, he was sentenced to 150 years in prison.

Madoff’s accountant, David Friehling, also plead guilty to charges of securities fraud, investment adviser fraud, and three counts of obstructing tax law administration. He is free on a $2.5 million bond and is cooperating with prosecutors while awaiting sentencing.


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Definition Sources


Definitions for Accounting Scandals are sourced/syndicated and enhanced from:

  • A Dictionary of Economics (Oxford Quick Reference)
  • Oxford Dictionary Of Accounting
  • Oxford Dictionary Of Business & Management

This glossary post was last updated: 26th November, 2021 | 1,165 Views.