Case 1-6
Accounting in Crisis
Kimberly G. Hester
Department of Accounting, Liberty University
ACCT 632-D01: Advanced Financial Accounting Theory
Dr. Wendy Achilles
July 4, 2021
The Sarbanes-Oxley Act was passed in 2002 after two significant companies collapsed as
a result of fraudulent reporting. The intention of the act was to re-establish trust in the integrity
of corporate financial reporting [ CITATION Wil05 \l 1033 ]. Was the act successful? There
were extra expenses incurred by the companies implementing the act. Were these additional
expenses worth the benefits? Conclusion: the jury is still out on both of these questions today.
But one might want to begin at the start of the scandals of the 2000s to form one's own opinion.
Enron Scandal
InterNorth Incorporated and Houston Natural Gas Company merged to form Enron, an
energy trader, and supplier in 1985. Enron Finance Corporation was created in 1990, with Mr.
Jeffrey Skilling named CEO [ CITATION Tro20 \l 1033 ]. Enron began to flourish.
Enron's accounting information system was transitioned to a mark-to-market accounting
that measures assets and liabilities by the accounts' fair market value. Opponents of this
accounting technique argue that it allows for manipulating the data because the fair market value
is more difficult to pin down than actual costs ([ CITATION Tro20 \l 1033 ]. The manipulation of
information is the beginning of the end for Enron.
By the mid-2000s, Enron was implementing approximately $350 billion in trades
[ CITATION Tro20 \l 1033 ]. However, when the recession hit in 2000, Enron entered earnings
based on the market's expected future growth, which inflated the numbers significantly.
By the fall of 2000, the company was crumbling, and the CEO was manipulating the
financials through mark-to-market accounting. This practice "led to schemes designed to hide the
losses and make the company appear more profitable than it was" [ CITATION Tro20 \l 1033 ]. In
August 2001, stock analysts began questioning the company's stock ratings. In October 2001,
Enron reported a loss of $618 million, a $1.2 billion write-off, and announces it is facing an SEC
commission probe. Enron files for Chapter 11 bankruptcy in 2001, and their
independent auditors, Arthur Andersen, get convicted of obstructing justice.
WorldCom Scandal
A leading telecommunication company, WorldCom, attempted to inflate the income on its
profit and loss statement by an estimated $4 billion in 2001 [ CITATION Jos20 \l 1033 ]. Scott
Sullivan, CFO, had access to all of the companies' accounting systems and fraudulently
reallocated billions of dollars in operating costs to capital expense accounts. This allowed
WorldCom to spread operating expenses over years instead of the year incurred. The fraudulent
reallocation caused the 2001 revenue to be inflated by approximately $3 billion, and WorldCom
reported profits of $1.4 billion [ CITATION Har20 \l 1033 ].
WorldCom admitted to fraud and wrongdoing in the summer of 2002 and filed for
bankruptcy, one of the largest in American history [ CITATION Jos20 \l 1033 ].
Sarbanes-Oxley Act of 2002
The high-profile scandals involving corporate CFOs are not new. However, after the fall
of these companies and many others, Congress passed the Sarbanes-Oxley Act. This act was
intended to improve "company oversight, strengthen and restore confidence in the auditing
profession's integrity, improve disclosure and financial reporting, and improve the gatekeepers'
performance" [ CITATION Wil05 \l 1033 ]. Legislation now makes it mandatory that all publically
traded companies implement secure audit and regulatory controls.
There is a barrier between a company's accounting firm and the auditing function since
SOX's enactment. The independent auditor must not be a member of the company's accounting
firm nor consult on the information system's design or implementation.
Conclusion
The Sarbanes-Oxley Act writer said, "capital will always go where it is welcome, and
stay where it is well treated" [ CITATION Wil05 \l 1033 ]. A company in compliance and "doing
the right thing" is a company headed for success in its eyes.
The writers must also realize that greed, pride, and the fraud triangle will always exist in
our world. One wishes that these things were not true, but unfortunately, they are. Proverbs
16:18 tells us, "Pride goes before destruction, And a haughty spirit before a fall." [ CITATION
The83 \l 1033 ]. One did not have to look far to find CFOs who were prideful in their jobs and
willing to manipulate numbers to show successful outcomes, no matter the cost.
References
Donaldson, W. H. (2019, April 21). Impact of the Sarbanes-Oxley Act. Retrieved from Securities and
Exchange Commission: https://www.sec.gov/testimony
Kennon, J. (2020, May 28). The WorldCom Scandal Explained. Retrieved from The Balance:
http://www.thebalance.com/worldcom-s-magic-trick-356121
Segal, T. (2020, September 22). Enron Scandal: The Fall of a Wall Street Darling. Retrieved from Guide To
Financial Crime and Fraud: http://www.investopedia.com/updates/enron-scandal-summary/
Smith, H. (2020, February 3). Obituaries. Retrieved from The Washington Post:
http://www.washingtonpost.com/local/obituaries/bernard-ebbers
The Holy Bible. (1983). Thomas Nelson.
