{"id":888,"date":"2015-04-24T20:32:00","date_gmt":"2015-04-24T20:32:00","guid":{"rendered":"https:\/\/courses.candelalearning.com\/masterybusiness1xngcxmaster\/?post_type=chapter&p=888"},"modified":"2015-10-06T14:40:35","modified_gmt":"2015-10-06T14:40:35","slug":"reading-challenges-facing-the-accounting-profession","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/chapter\/reading-challenges-facing-the-accounting-profession\/","title":{"raw":"Reading: Challenges Facing the Accounting Profession","rendered":"Reading: Challenges Facing the Accounting Profession"},"content":{"raw":"
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Accountant, Audit Thyself?<\/h2>\r\n<\/div>\r\n
\r\n\r\nConsider the following scenario. You feel good that you\u2019ve managed to create relevant, accurate, timely<\/em> financial statements for your first year in business as The College Shop, but you find that you\u2019re disappointed about one thing\u2014your net income figure. For some time now, you\u2019ve been trying to convince a friend to invest in The College Shop, telling him that the business would bring in at least $40,000 in income during its first year. Every time you review your\u00a0income statement, however, you\u2019re forced to face the fact that you earned just $30,000\u2014$10,000 short of your optimistic projection:\r\n\r\nRevenues \u2212 Expenses (CGS, operating expenses, interest and taxes) = Net income<\/span><\/span>\r\n$500,000 \u2212 $470,000 = $30,000<\/span><\/span>\r\n\r\nAs you stare one more time at your bottom line, you\u2019re wishing that there were\u00a0some way to change that single bothersome digit and transform $30,000 into $40,000. Then it hits you. You know that it\u2019s not exactly the most upright thing to do, but what if you were to shift half of your first-year advertising expense of $20,000 into your second year of operation? If you did that, then you\u2019d cut the advertising expense on your first-year income statement by $10,000. Now, with your newly acquired understanding of accounting principles, you know that if you reduce expenses on your income statement by $10,000, your net income will increase by the same amount. So just to see what your \u201crevised\u201d income statement would look like, you go ahead and make your hypothetical change. Sure enough, mission accomplished: Your income statement now reports a net income of $40,000\u2014your actual net income of $30,000 plus your upward \u201cadjustment\u201d of $10,000:\r\n\r\nRevenues \u2212 Expenses (CGS, operating expenses, interest and taxes) = Net income<\/span><\/span>\r\n$500,000 \u2212 $460,000 = $40,000<\/span><\/span>\r\n\r\nAlthough you now feel even more satisfied than ever with your newfound expertise in accounting strategy, you\u2019re once again forced to stop and think. If you merely change your net income and nothing else, the balance sheet won\u2019t balance anymore. Why not? Because when you inflated your net income to $40,000 and added it to your beginning owner\u2019s equity balance of $150,000, this increased your owner\u2019s equity by $10,000\u2014from $180,000 to $190,000. To make sure that you\u2019ve accurately assessed the snag in your strategy, you plug in the following accounting equation: assets = liabilities + owner\u2019s equity\r\n\r\nUnfortunately, this is what you get: $360,000 \u2260 $180,000 + $190,000.\r\n\r\nSo, now what? As you ponder the troublesome ramifications of your balance sheet, yet another accounting strategy pops into your head. At the end of the year, you still owed $6,000 for radio ads and $4,000 for newspaper ads\u2014$10,000 that\u2019s included in accounts payable<\/em> on your year-end balance sheet. What if you just reduced your accounts payable<\/em> balance by $10,000? If you did that, you\u2019d also reduce by $10,000 the amount under liabilities and owner\u2019s equity<\/em>, cutting it from $370,000 to $360,000. Wouldn\u2019t that make everything balance? Plugging in the numbers from your latest brainstorm, you now get $360,000 = $170,000 + $190,000.\r\n\r\nThat\u2019s more like it. Now you can go ahead and \u201cadjust\u201d your financial statements, satisfied that you\u2019re well on your way to mastering all of the accounting strategy that you\u2019ll need to handle the financial-reporting needs of your new business.\r\n
\r\n

Accounting \u201cStrategy,\u201d Ethics, and the Law<\/h2>\r\nUnfortunately, you may also be well on your way to becoming the Bernie Ebbers of the small-business set. In 2002, when the giant telecom company WorldCom collapsed under the weight of an $11 billion fraud scheme, CEO Ebbers, who was convicted of securities fraud and conspiracy, got twenty-five years in a federal penitentiary (\u201cI don\u2019t know accounting,\u201d he told the judge). And Ebbers wasn\u2019t the only person on the WorldCom payroll who was charged with illegal activities: Accounting department managers went down with him. Betty Vinson, for example, a forty-seven-year-old midlevel accountant who\u2019d followed orders to falsify accounting records, was sentenced to five months in jail. And she was lucky\u2014she got minimal jail time because she cooperated with federal prosecutors.<\/span>\r\n\r\nThe damage done at WorldCom spread to innocent employees as well, not to mention investors, creditors, and business partners. In 2001, when Enron, the seventh-largest company in America, melted down in the heat of an investigation into its financial-reporting practices, it took down an entire accounting firm with it\u2014eighty-nine-year-old Arthur Andersen, then one of the \u201cBig Five\u201d public accounting firms. Volumes have been written about what went wrong, but we can pretty much boil it down to this: Enron executives behaved unethically and illegally, and Andersen auditors looked the other way<\/em>. Instead of performing its role as public watchdog, Andersen was watching its own pocketbook: The accounting firm protected the revenues generated by lucrative consulting contracts with its client instead of protecting the client\u2019s stakeholders. In so doing, Andersen not only shirked its responsibilities as a public auditor but also covered up evidence of its own inappropriate actions.\r\n\r\nIn 2002, Andersen gave up its licenses to practice as certified public accountants in the United States, and a company that had employed 85,000 people only 10 years earlier now employs about 200, most of them to deal with lawsuits and to oversee the process of shutting down the company for good.<\/span>\r\n\r\n<\/div>\r\n
\r\n

Whom Can You Trust?<\/h2>\r\nIn a very real sense, the issue at the bottom of all this financial misconduct is trustworthiness<\/em>. As we\u2019ve seen, accountants are supposed to provide users<\/em> with financial reports that are useful<\/em> because they\u2019re relevant, timely, and, most important, accurate. It should go without saying that if users\u2014whether internal or external\u2014can\u2019t trust these reports to be accurate, they can\u2019t rely on them to be as useful as they should be. Would you, for instance, invest in or loan money to a company whose financial reports you can\u2019t trust?\r\n\r\nWhich\u2014appropriately\u2014brings us back to you and your little foray into falsifying accounting records. Let\u2019s say that in February of your second year of operations, you have an unexpected opportunity to expand into the vacated store right next to The College Shop. It\u2019s too good to pass up, but you\u2019ll need quite a bit of money to outfit the space and expand your inventory. First, you go to the friend for whose benefit you \u201cadjusted\u201d your financial statements, but he\u2019s just lost a bundle in the stock market and can\u2019t help you out. Your only option, then, is to get a bank loan. So you go to your banker, and some version of the following exchange occurs early in the conversation:\r\n

YOU:<\/strong>\r\nI need a loan.<\/p>\r\n

BANKER:<\/strong>\r\nLet me see your financial statements.<\/p>\r\n\r\n<\/div>\r\nShe means, of course, the first-year statements that you falsified, and if you\u2019re offered and accept a loan under these circumstances, you could be guilty of a financial crime that, according to the FBI, is normally characterized by \u201cdeceit, concealment, or violation of trust\u201d and committed \u201cto obtain personal or business advantage.\u201d The maximum you could get under federal law is twenty years, although your case no doubt calls for a sentence measured in mere months.<\/span>\r\n\r\n<\/div>\r\n

\r\n

Are You Ethical?<\/h2>\r\nWe could give you the benefit of the doubt and agree that you wouldn\u2019t have gotten yourself into this mess had you known the legal ramifications. We must assume, however, that you knew what you did was ethically<\/em> wrong. Ethics<\/strong> <\/em>refers to the ability and willingness to distinguish right from wrong and to know when you\u2019re doing one or the other. Ethical and trustworthy behavior is critical in both business and accounting, and although the vast majority of businesspeople and accountants behave ethically, all of them\u2014especially providers of financial information\u2014constantly face ethical dilemmas in the course of their work.\r\n\r\n<\/div>\r\n
\r\n

Sarbanes-Oxley Act (SOX)<\/h2>\r\nIt will be helpful to remember that both the law and the accounting profession have taken steps to remind you of your responsibilities when you\u2019re reporting financial information. In the wake of corporate scandals like the ones we described above, Congress passed the Sarbanes-Oxley Act (SOX)<\/span><\/span> of 2002, which was designed to encourage ethical corporate behavior and to discourage fraud and other forms of corporate wrongdoing. Among other things, SOX requires its top executives to take responsibility for a company\u2019s financial statements and subjects them to criminal penalties for falsely certifying its financial reports. SOX also set up the Public Company Accounting Oversight Board (PCAOB) to regulate accounting professionals, especially in the area of auditing standards.\r\n\r\n<\/div>\r\n
\r\n\r\nhttps:\/\/youtu.be\/D8ZbRLGmj6c\r\n

The Profession\u2019s Code of Ethics<\/h2>\r\nFinally, you can always turn to the Code of Professional Ethics of the American Institute of Certified Public Accountants (AICPA), which sets down two hallmarks of ethical behavior:<\/span>\r\n
    \r\n\t
  • Integrity<\/em>. An accountant should be \u201chonest and candid\u201d and should never subordinate the \u201cpublic trust\u2026to personal gain and advantage.\u201d<\/li>\r\n\t
  • Objectivity and independence<\/em>. An accountant should be \u201cimpartial, intellectually honest, and free of conflicts of interest.\u201d He or she is \u201cscrupulous in [the] application of generally accepted accounting principles and candid in all\u2026dealings with members in public practice.\u201d<\/li>\r\n<\/ul>\r\n<\/div>\r\n<\/div>\r\n
    \r\n
    \r\n
    \r\n
    \r\n

    KEY TAKEAWAYS<\/h3>\r\n
      \r\n\t
    • Current statutes and standards governing U.S. business and accounting practice reflect public reaction to a wave of corporate misconduct in the 2000s.<\/li>\r\n\t
    • Ethical and trustworthy behavior is critical in accounting because users trust accountants to provide financial reports that are relevant, timely, and, most important, accurate.<\/li>\r\n\t
    • The federal Sarbanes-Oxley Act (SOX)<\/strong> of 2002 was designed to encourage ethical corporate behavior and to discourage fraud and other forms of corporate malfeasance. The Code of Professional Ethics of the American Institute of Certified Public Accountants (AICPA) sets down two hallmarks of ethical behavior: integrity<\/em> and objectivity and independence<\/em>.<\/li>\r\n\t
    • If you choose a career in accounting, you have two career options: work as a public accountant or work as a private accountant.<\/li>\r\n\t
    • Public accounting firms<\/strong> provide clients with external audits<\/strong> in which they examine a company\u2019s financial statements and submit an opinion on whether they\u2019ve been prepared in accordance with GAAP. They also provide other accounting and tax services.<\/li>\r\n<\/ul>\r\n<\/div>\r\n<\/div>\r\n
      <\/div>\r\n
      <\/div>\r\n
      <\/div>\r\n
      \r\n

      Check Your Understanding<\/h2>\r\nAnswer the question(s) below to see how well you understand the topics covered in this section. This short quiz does not<\/strong> count toward your grade in the class, and you can retake it an unlimited number of times.\r\n\r\nUse this quiz to check your understanding and decide whether to (1) study the previous section further or (2) move on to the next section.\r\n\r\nhttps:\/\/assessments.lumenlearning.com\/assessments\/243\r\n\r\n<\/div>\r\n<\/div>\r\n<\/div>","rendered":"
      \n
      \n

      Accountant, Audit Thyself?<\/h2>\n<\/div>\n
      \n

      Consider the following scenario. You feel good that you\u2019ve managed to create relevant, accurate, timely<\/em> financial statements for your first year in business as The College Shop, but you find that you\u2019re disappointed about one thing\u2014your net income figure. For some time now, you\u2019ve been trying to convince a friend to invest in The College Shop, telling him that the business would bring in at least $40,000 in income during its first year. Every time you review your\u00a0income statement, however, you\u2019re forced to face the fact that you earned just $30,000\u2014$10,000 short of your optimistic projection:<\/p>\n

      Revenues \u2212 Expenses (CGS, operating expenses, interest and taxes) = Net income<\/span><\/span>
      \n$500,000 \u2212 $470,000 = $30,000<\/span><\/span><\/p>\n

      As you stare one more time at your bottom line, you\u2019re wishing that there were\u00a0some way to change that single bothersome digit and transform $30,000 into $40,000. Then it hits you. You know that it\u2019s not exactly the most upright thing to do, but what if you were to shift half of your first-year advertising expense of $20,000 into your second year of operation? If you did that, then you\u2019d cut the advertising expense on your first-year income statement by $10,000. Now, with your newly acquired understanding of accounting principles, you know that if you reduce expenses on your income statement by $10,000, your net income will increase by the same amount. So just to see what your \u201crevised\u201d income statement would look like, you go ahead and make your hypothetical change. Sure enough, mission accomplished: Your income statement now reports a net income of $40,000\u2014your actual net income of $30,000 plus your upward \u201cadjustment\u201d of $10,000:<\/p>\n

      Revenues \u2212 Expenses (CGS, operating expenses, interest and taxes) = Net income<\/span><\/span>
      \n$500,000 \u2212 $460,000 = $40,000<\/span><\/span><\/p>\n

      Although you now feel even more satisfied than ever with your newfound expertise in accounting strategy, you\u2019re once again forced to stop and think. If you merely change your net income and nothing else, the balance sheet won\u2019t balance anymore. Why not? Because when you inflated your net income to $40,000 and added it to your beginning owner\u2019s equity balance of $150,000, this increased your owner\u2019s equity by $10,000\u2014from $180,000 to $190,000. To make sure that you\u2019ve accurately assessed the snag in your strategy, you plug in the following accounting equation: assets = liabilities + owner\u2019s equity<\/p>\n

      Unfortunately, this is what you get: $360,000 \u2260 $180,000 + $190,000.<\/p>\n

      So, now what? As you ponder the troublesome ramifications of your balance sheet, yet another accounting strategy pops into your head. At the end of the year, you still owed $6,000 for radio ads and $4,000 for newspaper ads\u2014$10,000 that\u2019s included in accounts payable<\/em> on your year-end balance sheet. What if you just reduced your accounts payable<\/em> balance by $10,000? If you did that, you\u2019d also reduce by $10,000 the amount under liabilities and owner\u2019s equity<\/em>, cutting it from $370,000 to $360,000. Wouldn\u2019t that make everything balance? Plugging in the numbers from your latest brainstorm, you now get $360,000 = $170,000 + $190,000.<\/p>\n

      That\u2019s more like it. Now you can go ahead and \u201cadjust\u201d your financial statements, satisfied that you\u2019re well on your way to mastering all of the accounting strategy that you\u2019ll need to handle the financial-reporting needs of your new business.<\/p>\n

      \n

      Accounting \u201cStrategy,\u201d Ethics, and the Law<\/h2>\n

      Unfortunately, you may also be well on your way to becoming the Bernie Ebbers of the small-business set. In 2002, when the giant telecom company WorldCom collapsed under the weight of an $11 billion fraud scheme, CEO Ebbers, who was convicted of securities fraud and conspiracy, got twenty-five years in a federal penitentiary (\u201cI don\u2019t know accounting,\u201d he told the judge). And Ebbers wasn\u2019t the only person on the WorldCom payroll who was charged with illegal activities: Accounting department managers went down with him. Betty Vinson, for example, a forty-seven-year-old midlevel accountant who\u2019d followed orders to falsify accounting records, was sentenced to five months in jail. And she was lucky\u2014she got minimal jail time because she cooperated with federal prosecutors.<\/span><\/p>\n

      The damage done at WorldCom spread to innocent employees as well, not to mention investors, creditors, and business partners. In 2001, when Enron, the seventh-largest company in America, melted down in the heat of an investigation into its financial-reporting practices, it took down an entire accounting firm with it\u2014eighty-nine-year-old Arthur Andersen, then one of the \u201cBig Five\u201d public accounting firms. Volumes have been written about what went wrong, but we can pretty much boil it down to this: Enron executives behaved unethically and illegally, and Andersen auditors looked the other way<\/em>. Instead of performing its role as public watchdog, Andersen was watching its own pocketbook: The accounting firm protected the revenues generated by lucrative consulting contracts with its client instead of protecting the client\u2019s stakeholders. In so doing, Andersen not only shirked its responsibilities as a public auditor but also covered up evidence of its own inappropriate actions.<\/p>\n

      In 2002, Andersen gave up its licenses to practice as certified public accountants in the United States, and a company that had employed 85,000 people only 10 years earlier now employs about 200, most of them to deal with lawsuits and to oversee the process of shutting down the company for good.<\/span><\/p>\n<\/div>\n

      \n

      Whom Can You Trust?<\/h2>\n

      In a very real sense, the issue at the bottom of all this financial misconduct is trustworthiness<\/em>. As we\u2019ve seen, accountants are supposed to provide users<\/em> with financial reports that are useful<\/em> because they\u2019re relevant, timely, and, most important, accurate. It should go without saying that if users\u2014whether internal or external\u2014can\u2019t trust these reports to be accurate, they can\u2019t rely on them to be as useful as they should be. Would you, for instance, invest in or loan money to a company whose financial reports you can\u2019t trust?<\/p>\n

      Which\u2014appropriately\u2014brings us back to you and your little foray into falsifying accounting records. Let\u2019s say that in February of your second year of operations, you have an unexpected opportunity to expand into the vacated store right next to The College Shop. It\u2019s too good to pass up, but you\u2019ll need quite a bit of money to outfit the space and expand your inventory. First, you go to the friend for whose benefit you \u201cadjusted\u201d your financial statements, but he\u2019s just lost a bundle in the stock market and can\u2019t help you out. Your only option, then, is to get a bank loan. So you go to your banker, and some version of the following exchange occurs early in the conversation:<\/p>\n

      YOU:<\/strong>
      \nI need a loan.<\/p>\n

      BANKER:<\/strong>
      \nLet me see your financial statements.<\/p>\n<\/div>\n

      She means, of course, the first-year statements that you falsified, and if you\u2019re offered and accept a loan under these circumstances, you could be guilty of a financial crime that, according to the FBI, is normally characterized by \u201cdeceit, concealment, or violation of trust\u201d and committed \u201cto obtain personal or business advantage.\u201d The maximum you could get under federal law is twenty years, although your case no doubt calls for a sentence measured in mere months.<\/span><\/p>\n<\/div>\n

      \n

      Are You Ethical?<\/h2>\n

      We could give you the benefit of the doubt and agree that you wouldn\u2019t have gotten yourself into this mess had you known the legal ramifications. We must assume, however, that you knew what you did was ethically<\/em> wrong. Ethics<\/strong> <\/em>refers to the ability and willingness to distinguish right from wrong and to know when you\u2019re doing one or the other. Ethical and trustworthy behavior is critical in both business and accounting, and although the vast majority of businesspeople and accountants behave ethically, all of them\u2014especially providers of financial information\u2014constantly face ethical dilemmas in the course of their work.<\/p>\n<\/div>\n

      \n

      Sarbanes-Oxley Act (SOX)<\/h2>\n

      It will be helpful to remember that both the law and the accounting profession have taken steps to remind you of your responsibilities when you\u2019re reporting financial information. In the wake of corporate scandals like the ones we described above, Congress passed the Sarbanes-Oxley Act (SOX)<\/span><\/span> of 2002, which was designed to encourage ethical corporate behavior and to discourage fraud and other forms of corporate wrongdoing. Among other things, SOX requires its top executives to take responsibility for a company\u2019s financial statements and subjects them to criminal penalties for falsely certifying its financial reports. SOX also set up the Public Company Accounting Oversight Board (PCAOB) to regulate accounting professionals, especially in the area of auditing standards.<\/p>\n<\/div>\n

      \n