It is said that the equity and credit markets (capital markets) in the United States are among the most efficient in the economically developed world. A major reason for the efficient operation of these markets is that their organizations have made their financial statements available to individuals and institutions, and investment and credit decisions are based on the confidence of users in these very statements. Hence, the episodes of fraudulent financial statements that have rocked the very foundations of corporate America serve as serious potential threats to the efficient functioning of these markets (Mancino, 1997).
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By definition, fraudulent financial reporting happens when either intentionally or recklessly, the materially relevant information is omitted or altered, or presented in a misleading way to its readers. When the organization is misrepresented, or any situation or the prospects of an organization are represented incorrectly on its financial statements, this is known as misleading financial analysis (Mancino, 1997).
This type of deceit can serve several purposes. For example, it can be used to obtain money from people by misdirecting them to invest in a stock market bubble. The company behind this fraud would benefit from the increase in value and then before the bubble collapses, it would remove funds and cause a stock market crash. When such instances of fraudulent reporting are made public, they often lead to diminished confidence in the operation of equity markets and an erosion in the system of public disclosure as its basic purpose of transparency is violated (Mancino, 1997).
It also creates an ethical dilemma, and ethical practices are of utmost importance in accounting, both for professionals and the people who rely on their services. Certified Public Accountants and other accounting professionals are aware of the fact that people who employ their services, especially the decision-makers who base their decisions on the financial statements of companies, expect these statements to be highly competent, reliable, and unbiased. Hence, it is critical for accountants to not only be well qualified but also to possess a high degree of morality and professional integrity. In the field of accounting, these factors are a person’s most important possessions (Mancino, 1997).
The high-profile scandals at Enron, WorldCom, Global Crossing, and Tyco, among numerous others, coupled with the notorious dissolution of the audit firm Arthur Anderson, are not just business failures. They represent serious ethical failures of the management and a failure to meet the expectations which society places on professionals, to meet some core moral standards while conducting business. They stand for the hollowing of the lengthy codes of ethics and professional conduct which companies often advertise, as society’s confidence is shattered in the ability of companies to maintain a level of discipline which goes beyond the requirements of laws and regulations (Boatright, 2003).
While the scandals of recent times mentioned above have been deeply entrenched in society’s memory, there have been many others even before them. One example is that of Kirschner Medical Corp., a manufacturer of orthopedic equipment based in Baltimore. It went public in 1986 and from $6.5 million, reached $55 million in revenues in 1989. As a result, stock prices touched the sky as well. But the investors who rushed to get a piece of the profits to claim now that they were misled by the company. The company underwent massive losses in 1989 and 1990 as well, even though it promised a quick rebound. During this time, the company allegedly concealed information about defective products, obsolete inventories, and a European plant that was operating at a loss. When this bad news finally reached the public, stock prices crashed and market value declined by $35.7 million. More than a thousand investors filed a class-action suit against the company and its executives claiming fraudulent financial reporting (Braiotta, 1992).
The egregious failures of executives, investment bankers, lawyers, auditors have all been made public and these represent a lapse in their promise to fulfill their basic fiduciary duties to serve the interests of their shareholders as well as the general public. Executives had pledged to fulfill to serve these entities and yet, have been found guilty of manipulating earnings, hiding debts, and furnishing false accounting records so that they can enjoy their luxurious stock options, all at the expense of their shareholders. Accountants who have been employees of small and big firms alike have performed audits of these firms for the benefit of the investing public, and time and time again, have allowed many instances of so-called ‘creative accounting’ or ‘aggressive accounting’ and have approved financial statements which have been proved to be falsely construed. Investment bankers have also participated in the chain of deceit: they have helped executives to develop complicated financial transactions which enabled the generation of phantom earnings and inflated the income statements, or removal of unwanted debt records from the balance sheet (Boatright, 2003).
All of this has eroded the ethical fabric of the accounting profession as well as diminished the trust of the general public in the financial statements which are prepared by companies and approved by auditors. To maintain a certain ethical standard, companies should ensure that their financial statements are prepared with utmost integrity and objectivity and not as a tool enabling them to deceive the public at large and investors in particular.
- Boatright, J. (2003). Ethics for a Post-Enron America. Phi Kappa Phi Forum, 83 (2), 10-15.
- Braiotta, L. (1992, May). Preventing fraudulent reporting: Auditing for honesty. ABA Journal, 76-79.
- Mancino, J. (1997, April). The Auditor and Fraud. Journal of Accountancy, 32-36.