The Need For Reforms To Corporate Governance Accounting Essay

This essay briefly discusses the events that led to the bankruptcy of Enron – Americas 7th largest corporation CNN money, online and disintegration of Arthur Anderson – one the World ‘s top 5 audit and accounting partnerships in 2001. It aims to critically evaluate developments in the audit profession and model in respect to corporate administration, internal controls and function of ethical judgements after the exposure of Enron ‘s dirt. It farther discusses whether such developments and regulative models provide confidence that the history of Enron could ne’er reiterate itself in the UK.

The Historic Failure

The executives at Enron -‘The Most Innovative Company in America ‘ harmonizing to Fortune ‘s Most Admired Companies Survey ( Stein, 2000 ) adopted a variegation scheme and worked diligently to maintain their stock monetary values up. They manipulated their histories, showed assets at hyperbolic values and kept considerable debts off their balance sheet. Even failed undertakings that resulted in losingss were shown as profitable due to their mark-to-market accounting policy. This policy allowed them to presently enter net incomes on the footing of future anticipated grosss whether or non such net incomes could really be realized ( Thomas, 2002 ) . The inability to follow the exact beginning of income to Enron net incomes raised a batch of inquiries in the heads of analysts and investors. Even the appointed audit house – Arthur Andersen which was one of the universe ‘s top 5 audit houses behaved unethically towards the duty entrusted upon them. They failed to unwrap the right fiscal place of Enron due to the stuff benefits they were having from the client which finally led to their disintegration and 85,000 employees losing their occupations ( Jackling et al, 2007 ) . As a consequence, in December 2001, Enron was declared insolvent ( BBC News, online ) and this came to be known as the largest corporate bankruptcy in US history and the biggest audit failure at the clip.

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The Need For Reforms To Corporate Governance

The UK has non remained immune to such extortionate dirts. The Cadbury Report in 1992 and Hampel Report in 1998 were consequences of the immediate reforms needed to the corporate administration in the UK after the instance of Maxwell Communications and Polly Peck of the 1990 ‘s.

Post Enron 2001, WorldCom, Global Crossing, Adelphia and many other corporations shortly fell in the US within the span of one twelvemonth. Italy ‘s Parmalat and Australia ‘s HIH Insurance and One Tel followed the same conference ( Jackling et al, 2007 )

Such disgraceful bankruptcies and prostrations led to the audit profession ‘s effectivity coming under great unfavorable judgment and examination and the loss of assurance in the fiscal coverage and answerability by investors and other stakeholders.

The US, to reinstate investor assurance through corporate administration responded by go throughing The Sarbanes-Oxley Act in 2002 which disallowed an external hearer to execute both scrutinizing and confer withing services to the same client.

Corporate administration is the procedure by which organisations are directed, controlled and held accountable for the determination devising, control and behaviour at the top of the organisation ( Collier, 2008 ) .

In big corporations and publically listed companies there is a separation of ownership and direction which gives rise to the agent-principal relationship. The directors ( agents ) are appointed by stockholders ( principals ) to take attention of twenty-four hours to twenty-four hours operations in a manner that they safeguard the involvement of the stockholders. However, sometimes directors may move in self involvement pretermiting their duty towards the proprietors of the house. This gives rise to a struggle of involvement.

Traditional corporate administration was aimed at deciding struggles of involvement on the footing of this agent-principle relationship. Due to distrust that the stockholders may hold on the directors, they appoint independent hearers to analyze the operations and fiscal statements of the house to guarantee the involvement of stockholders is safeguarded and directors are non working in self involvement.

This traditional theory of directors being responsible for increasing stockholders wealth has expanded to a much broader construct today. Directors are now non merely accountable to the stockholders but to all those parties that are affected by the operations of the organisation. This signifies a displacement from a short term scheme of protecting the involvement of stockholders entirely to a long term scheme where the involvement of all stakeholders of the house are protected ( Brenan and Solomon, 2008 ) .

Delegating duty to directors and doing them accountable to internal ( executives, board of managers and employees ) and external stakeholders ( stockholders, debt holders, creditors, providers, clients and society ) forces them to be socially responsible, crystalline and unwrap all material information in the fiscal statements that may be considered critical to stakeholders in doing a pick of covering with the house.

A company operates as a legal entity and is capable to different Torahs and ordinance. Such rules and codifications of corporate administration differ from state to state as they are issued by their several stock exchanges, institutional investors or associations with support of the authorities and international corporations. Firm ‘s conformity to these codifications of pattern is non compulsory. However if the house wishes to be listed on the stock exchange it needs to follow with their ordinances and any instance of non-compliance demands to be disclosed with justifiable accounts. Despite the fact that Enron disclosed their move to follow the mark-to-market accounting, the SEC nor the external hearers used their professional incredulity to ask inside informations of their hard currency flows.

Though corporate administration failed to forestall deceitful and malpractices in the Enron instance, its importance can non be dismissed. Assorted mechanisms like assignment of non-executive managers, dividing the function of the Chairman and Chief Executives and debut of board bomber commissions such as the audit commission have proved to be effectual steps to better managerial public presentation. SOX have besides put a cap on the fee which an audit house can have as a per centum of their entire fees from one client to guarantee independency while transporting out the audit. US Treadway Commission of 1987 and the UK Turnbull Report of 1999 and 2005 have besides highlighted that internal control forms a cardinal facet of the corporate administration model ( Brenan and Solomon, 2008 ) .

Internal Control Over The Old ages

As the term suggests, internal control is the system of commanding from within. It works to assist the organisation run into its ends and aims in an effectual and efficient mode. Its primary duty is to guarantee fiscal studies are dependable and supply accurate information and that the organisation is following with the Torahs and ordinances regulating their operations ( Fadeil, Haron and Jantan, 2005 ) . They are besides responsible for supplying sensible confidence ( non absolute confidence ) that the fiscal statements are complete, free of mistake or fraud and the assets of the house are safe from loss or larceny ( Jones, 2008 ) .

Many at times there exists an outlooks spread due to misconstruing the function and duty of external hearers. Detection of fraud is non the primary duty of the hearers but of the direction. The duty of the external hearer is to simply guarantee and certify whether the financials are free of fraud or non.

Control environment, hazard appraisal, information sing fiscal coverage and communicating, supervising through internal audit and control activities form the 5 constituents of internal control ( Jones, 2008 ) .

The range of internal control has expanded massively after the Enron dirt. Now internal control has become a cardinal constituent of hazard direction. The limited liability of managers served as an immunisation tool for their foolhardy behaviour and working for personal motivations. By delegating answerability to the stakeholders and doing the managers apt for intentionally misdirecting the users of fiscal statements will coerce them to move responsibly and cut down fraud. Enron portions that were selling at above $ 90/share in 2000 became worthless and their value fell below $ 1/share in 2001 after the exposure of Enron ‘s existent fiscal place and this had annihilating effects on its stakeholders. There has already been a important move towards a more controlled environment in the US like it is in the UK as it is believed that it will move as a shield to fraud and prevent malpractices from repeating ( Spira and Page, 2003 ) .

Presents, after the passing of the Sarbanes-Oxley Act, under subdivision 404, external hearers are required to describe on the operation of their client ‘s internal control systems and must attest if they are effectual in executing their responsibilities. Prior to SOX, direction had an option non an duty to adhere to the alterations suggested by the external hearers.

The External hearers are allowed to work aboard the direction and help them to reconstitute their internal control systems. This is in contradiction to the SOX as under this Act the External Auditor is non allowed to execute non-audit services due to independence being jeopardized and the hearer will be measuring and judging his ain work ( Tackett, Wolf and Claypool, 2006 ) .

The Internal Auditors act independently and oversee the operation of the Internal Controls moving as a police officer looking for defects in the system. They besides act as concern spouses assisting the steadfast meet its ends ( Fadeil, Haron and Jantan, 2005 ) .

Role Of Ethical Considerations

Ethical considerations from an accounting point of position would necessitate an addition in the morality of comptrollers and hearers towards their responsibilities and duties. One of the biggest jobs at Enron was the deficiency of moral and ethical duty. Like directors are accountable to non merely stockholders but to all the stakeholders, comptrollers and hearers have an ethical duty of unwraping all material information to the stakeholders who may utilize the fiscal statements as they perform the responsibility of mediators between them and the direction. Any incorrect information that is attested by the hearers could do inauspicious affects to the stakeholders.

Ethical motives help to do a clear differentiation between what ought to be done and what is the right thing to be done. Accountants/auditors must adhere to their criterions of professionalism set out by their professional organic structures and move independently to use the best determinations to their pattern.

Barlaup, Dronen and Stuart ( 2009 ) described moralss as the right thing to be done and identified 3 basic theories to explicate them:

Egoism – the theory of ego involvement where the right thing to make is profit yourself.

Utilitarianism – where the right thing to make is that which brings felicity to most of the people.

Deontology – where the right thing to make is talk the truth regardless of its effects.

Equally far as possible comptrollers and hearers are expected to follow the theory of deontology as moving in self involvement and doing unqualified professional judgements may take to ethical radioactive dusts.

After Enron, professional accounting organic structures have played an of import function in seeking to cut down originative accounting patterns through educating their members about their ethical duties to the society. They have tried to instill professional values such as unity, objectiveness, professional competency and due attention, confidentiality and professional behaviour of following with the regulations and ordinances. They besides train, support employees within an organisation to be true and tackle hard state of affairss that may necessitate ethical responses.

This step will assist professionals to be more sensitive to ethical issues and use the right professional judgement in their work topographic point ( Jackling et al, 2007 ) .


There have been many claims that what happened at Enron in the US ten old ages ago could ne’er go on in the UK ( Holt and Eccles, 2002 ) . There are assorted grounds why this may keep true. First, accounting in the UK is based on by and large accepted accounting rules non on elaborate normative regulations like in the US. Establishing histories on general rules allows comptrollers to utilize their professional judgement while covering with assorted points to demo a true and just position. Second, mark-to-marketing accounting would ne’er be allowed in the UK as it assumes really favourable conditions to merchandise which can non be guaranteed in an of all time altering environment. The corporate administration steps in topographic point, increasing function of internal controls, supervising through internal and external hearers with an independent position, revised accounting criterions and turning consciousness of ethical and moral duty act as a hindrance to perpetrating fraud if non wholly extinguishing them. Thus it would be safe to state that with the current accounting model it is extremely impossible for a fraud of a quality like that of Enron could be repeated. Not merely in the UK but commissariats to the accounting model have been made all around the Earth and are ever under changeless alteration. It is expected that by 2014 even the US will accept the IFRS and regulate its accounting on the footing of rules non regulations.