The Enron Scandal, uncovered in 2001, was one of the largest accounting frauds in history. The fraud occurred as a result of accounting gaps and poor financial reporting which allowed top executives to conceal billions of debts from failed deals and projects. The company’s CFO and other executives not only lied to its BOD and audit team on risky accounting norms, but also pressed Arthur Andersen to ignore the issues.
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Arthur Andersen was handling Enron’s auditing activities during this period. As a result of the Enron scandal, shareholders lost billions of dollars and the company was eventually declared bankrupt. Arthur Andersen willingly surrendered its licenses to practice auditing in the US and sold most of its practices (Healy & Palepu, 2003).
As a result of the scandal, a number of regulations were implemented by the government to prevent similar activities from happening again. The most common piece of legislation implemented was the Sarbanes–Oxley Act.
This act was signed into law in 200 and hence sometimes referred to as the Sarbanes–Oxley Act of 2002. The act set new or improved standards for all American-based public company boards, management and public accounting and auditing companies (Kuschnik, 2008). The act was enacted following a series of accounting scandals by large corporations in the US, including Enron, Tyco International and WorldCom. The scandals cost shareholders and tax collection agencies billions in dollars, affected share prices, and led to the collapse of some of the companies.
The Sarbanes–Oxley Act comprises of 11 titles ranging from supplementary management board roles to criminal penalties, and compels the Securities and Exchange Commission (SEC) to implement the outlines of the act. Key provisions of the act include disclosure controls, improper influence on conduct of audits, disclosures in quarterly reports, evaluation of internal controls, and criminal penalties for violating the provisions of the act (Farrell, 2005).
Under disclosure controls, the Act sets out internal processes aimed at ensuring accurate financial reporting. The signing officers must verify that they are “responsible for establishing and maintaining internal controls” and the officers must have assessed the efficiency of the firm’s internal controls as current three months prior to the report (Kuschnik, 2008).
Further, external auditors are obliged to provide their opinions on the effectiveness of the internal controls during financial reporting (Kuschnik, 2008). The title on improper influence on conduct of audits states that is illegal for an officer (or any other person acting under the commission’s mandate) to partake in any activity meant to falsely sway, force, influence, or misinform any independent public or certified accountant undertaking audit of the financial statements of that company.
Under the title on disclosures in quarterly (or periodic) reports, the Act requires the disclosure of all material off-balance sheet items. The SEC is further expected to monitor the use of such instruments and whether accounting doctrines have been thoroughly adhered to in the use of such instruments.
Finally, under evaluation of internal control, management is obliged to give an “internal control report” that confirms the management’s role of setting up and maintaining an acceptable internal control structure and techniques for financial reporting (Kuschnik, 2008). The report must also contain an evaluation as of the end of the most recent financial year of the firm, of the efficiency of the internal control structures and processes.
The Sarbanes–Oxley Act has been commended by a number of financial industry experts, quoting enhanced investor confidence and more precise periodic and fiscal financial reports.
Farrell, G. (2005). America Robbed Blind. Texas: Wizard Academy Press.
Healy, P. M. Palepu, K. G. (2003). The Fall of Enron. Journal of Economic Perspectives, 17(2), 7.
Kuschnik, B. (2008). The Sarbanes Oxley Act. Business Law Journal, 18(6), 64 – 95.