REAPING THE FRUITS OF EVIL: HOW SCANDALS

HELP RESHAPE THE ACCOUNTING PROFESSION

Augustine Enofe
Argosy University

ABSTRACT
Economic scandals of the 21st Century were due to corporate executive greed that
translated into fraudulent financial reporting. The aftermath of these scandals help reshaped the
accounting profession and financial reporting standards. This study will qualitatively examine the
history of fraud in the accounting profession, reasons why corporations and corporate executives
take part in fraudulent activities, the governments reaction to these fraudulent activities, and the
resulting benefits derived from the scandal by the public accounting profession.
Keywords: Enron, Worldcom, Parmalat, Tyco, HealthSouth, Quest, Citigroup, SEC, CPA, Mckesson-Robbin,
ZZZZ Best, Sarbanes-Oxley, PCAOB

INTRODUCTION
For over a decade, the accounting profession has been gripped with scandals and
fraudulent financial reporting. Management fraud has rocked the foundation of some of the
worlds major corporations such as Enron, WorldCom, Parmalat, Tyco, HealthSouth, Quest, and
Global Crossing (Badawi, 2005), to name a few. Such devastation has resulted in loss of jobs,
pensions, and homes for thousands of employees (Badawi, 2005). The scandals also led to the
dissolution of a major public accounting firm and the discovery of widespread manipulation of
mutual funds. The root of the problems could be attributed to the pressure on corporate
accountants, auditors, and upper management to show profits (Wells, 2005). These aggressions
may have led to the unethical decision that resulted in such scandalous consequences. The all
important question is what will motivate an employee to obey unethical directives from a
superior? Is it for fear of losing their job? Some reasons posited by practitioners and academia
as to why people obey instructions they know to be wrong are fear, adverse setbacks, loss of
advancement opportunity, cold treatment by other employees, and being accused of not being a
team player.
Many executives prefer to surround themselves with people who think the way they do
and support them rather than criticize their decisions, irrespective of the danger of such decisions
(Flegm, 2005). A common thread among the companies that are involved in financial scandal is
the gross lack of integrity, character, and transactions involving related parties (Geriesh, 2006).
Integrity and character are values that are not subject to negotiation. These values are innate, not
learned; and therefore, are not attributable to everyone, otherwise everyone would have them.
The lesson learned from these corporate failures and financial scandals is that integrity and
character are expensive and important qualities to achieve corporate success and prevent the
reoccurrence of the corporate turbulence that has engulfed the accounting profession over the
past decade.

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In todays global economy, business has become so complex. Business transactions are
more complicated than ever before. Revenue recognition has become a major issue as business
people construct complicated deals with different types of revenue streams and conditions
(Marshall, 2004). For instance, Enron was helped by Citigroup to disguise significant amounts
of debt as commodity prepay transactions. Through a series of circular prepaid transactions and
special purpose entities (SPE), Enron was able to borrow money and the proceeds were recorded
as cash generated from operations. The latter worked because prepaid commodity contracts are
generally recorded as trades, and not loans (Knowledge@W.P.Carey, 2006). The motivation
was to boost corporate profits and increase managements annual compensation. What was
wrong with that?
This study will qualitatively examine the history of fraud in the accounting profession,
reasons why corporations and corporate executives take part in fraudulent activities, the
governments reaction to these fraudulent activities, and the resulting benefit to the public
accounting profession.
PROBLEM BACKGROUND
In 2001, the Enron Corporation, a major energy company, acknowledged fraudulent
financial reporting over the previous five years. The company deviated from generally accepted
accounting principles in preparation of its financial statement. Instead of the massive profits
reported that same period, the company actually had a lost of $586 million (Meyer, 2005).
Enron may have led the way in the exploitation of special purpose entities to keep liabilities off
their balance sheet, but the others in the industries did not lag far behind (Coffee, 2005).
In 2002, WorldCom, the number two U.S. long-distance telephone and data services
provider, announced that it would have to revise its recent financial statement to the tune of
$3.85 billion. Investors, analysts, and the public were left shaking their heads as previously
reported profits suddenly turned out to be losses. An internal audit revealed these accounting
irregularities (Knowledge@Wharton, 2002). Unlike Enron, WorldCom transferred obvious
expenses into capital expenditures. Such expense was supposed to have been recognized in the
period incurred, and not as a capitalized asset. The mischaracterization of these expenses to
capital assets led to the artificial inflation of the companys net income.
In 2002, Qwest, another telecom giant, had its Chief Executive Officer (CEO) and six
other former executives sued by the Securities & Exchange Commission (SEC) for allegedly
taking part in what regulators called massive financial fraud. The complaint filed accused the
group of engineering a $3 billion scheme to inflate Qwest revenues from 1999 to 2002 by
backdating contracts and unnecessarily initiating swaps of network capacity, as well as pushing
up publication dates of the companys phone directories (Palmeri & Borrus, 2005).
These are a few examples of many of the companies that were involved in financial
statement fraud within the last decade. Things got out of hand and some companies were
required to go back and restate previously certified earnings. These restatements led to an
immediate market-adjusted decline of almost 10 percent in the affected companys stock price.
One commonality among these companies is the motivation of corporate management to
engage in acts of deceit and fraud for personal gain.

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PROBLEM HISTORY
To some Certified Public Accountants (CPAs), what happened with the financial
statements of Enron, WorldCom, and Tyco is simple to explain: Individuals committed fraud
through the manipulation of their companys financial statements in order to inflate the market
price of their companys stock, and by extension, the individuals stock options. It is very
tempting to write-off these episodes to greed. This explanation, if true, can be used to absolve the
auditing professional of blame for the fraud problem facing the profession, since many
accounting professionals have long believed that the investigation of fraud is beyond the scope of
the normal audit engagement (Razaee, 2002). From their viewpoint, the real problem with fraud
detection and audit engagements is that the public does not understand what an audit actually
entails, leading to false public expectations of an auditors duties and responsibilities (McEnroe
& Martens, 2001).
The problem with this argument is that fraud and financial statement manipulation has
been a recurring theme in the history of the accounting profession in the United States. While it
is true that financial statement audits have not necessarily been designed to detect fraud
(Hermann, 2003; Carnes & Gierlasinski, 2001), the auditing profession has ignored this
misconception for over 100 years. The evidence shows that in many of the economic cycles of
the United States, the end of the cycle has usually shown evidence of significant accounting
fraud.
From its earliest beginnings, the accounting profession has had to deal with fraud. During
the Gilded Age, fraud actually had a positive affect on the profession, because the auditing
profession began to develop as a tool to meet the needs of businesses. As a result of the
increasing use of the corporate form of organization, there was an increasing need for
accountants to detect improper entries, errors, and fraud in the records and books of companies.
This was important because defalcations, breaches of trust, irregularities, and swindling schemes
were common occurrences during that time. In fact, two out of three new audit engagements that
occurred during the 1890s were likely to find evidence of defalcations. Auditing techniques and
theory developed to meet these threats, and resulted in the beginnings of the profession (Previts
& Merino, 1998).
It soon became apparent, however, that the profession would abandon fraud detection and
prevention as the primary objective of auditing. Accountants concluded that audits could not be
designed to specifically detect fraud due to the cost and increasing size of corporations (Carnes
& Gierlasinski, 2001). It also became apparent that many in the investing communities and
regulatory agencies could care less about fraud. Finally, many in the accounting profession
argued that the primary cause of fraud in the early 1900s, financial manipulation through the use
of no-par stock and surpluses, was legal and beyond the control of accountants (Previts &
Merino, 1998).
The result of this de-emphasis of fraud detection in financial audits was the widespread
belief that audited financial statements had no value. By the early 1920s, many investors
believed that only audits performed by large, reputable accounting firms were reliable. A case
of fraud that developed in the late 1930s was to shatter even this belief.
The McKesson-Robbins case of the late 1930s was viewed by many in the auditing
profession as a classic case of collusive fraud. Because of the nature of fraud during this period,
many accounting professionals were not that concerned about what had happened. In the minds
of the accounting professionals, it was difficult and ineffective to design a financial statement
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audit that would detect this type of fraud. For this reason, and the belief of many accountants that
the McKesson-Robbins auditors were just following GAAP (Baxter, 1999), the professions
leadership saw no reason to change the auditing procedures used at the time.
The latter proved to be a severe misjudgment on the part of the profession. Because of the
nature of the case, the press treated the case in a sensational manner. This resulted in public
hearings in New York, where many prior cases were cited to illustrate the fundamental
weaknesses of financial statement audits in detecting fraud. Although the professions leadership
argued that human behavior, not lack of procedures, had been the primary cause of all these
defalcations, the subsequent negative publicity caused the American Institute of Accountants
(AIA) to extend accepted auditing procedures (Baxter, 1999).
With the publication of Extensions of Auditing Procedures in 1939, the AIA
acknowledged the need for changes in auditing procedures. Auditors were now required to
confirm receivables and verify the existence of inventory. In addition, auditors were now
required to review the auditees system of internal control to determine the extent to which it
could be relied upon (Previts & Merino, 1998).
The result of this perceived failure of the profession to detect fraud through auditing
procedures was the loss of support for the profession among its biggest supporters. The lack of
fraud detection, combined with the re-writing of the standard audit certificate earlier in the
decade in an attempt to limit auditors potential liability arising from audit work, convinced both
the stock exchanges and major investors that audited financial statements were unreliable even
when prepared by the most reputable accounting firms. No longer could investors trust auditors
to protect their interests, since an audit certificate proved nothing about the financial health of a
company. The question many critics of the accounting profession asked was What purpose do
auditors serve if they do not protect investors and other societal interests? (McEnroe & Martens,
2001).
This question, and the controversy surrounding the McKesson-Robbins case, faded from
memory with the arrival of World War Two and the economic expansion that arrived in the
United States following the war. Fraud still occurred from time to time, but the economic
growth of the period tended to allow accountants, government regulators, and the general public
to ignore the problem of fraud and auditing. This problem avoidance ended with the slowdown
of the economy in the early 1980s and the detection of several significant frauds involving
fraudulent financial statements.
Since frauds such as ZZZZ Best, ESM Securities, and the savings and loan crisis all
involved some form of financial statement manipulation; the old unanswered question from the
1930s again became relevant. Unlike the 1930s however, not everyone was willing to ignore the
problem or allow the accounting profession to address the problem itself. It soon became
apparent that there was a gap between what the investors, regulators, and the public expected
from an audit and auditors, and what an audit and auditing procedures actually entailed
(McEnroe & Martens, 2001).
The initial reaction of many in the profession was to repeat the long held notion that
management, not auditors, was responsible for the companys financial statement; and those
auditors who take reasonable care in planning and performing their audit should not be held
responsible for managements misrepresentations. Many accountants feared that the mistrust of
people in positions of responsibility that had arisen in the post-Watergate era, and the increasing
legal liabilities being placed on the profession due to business failures, were the real threats to
the profession that needed to be addressed. In their view trying to meet ill-defined expectations
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of various groups, which were often contradictory, would only expose the profession to more
distrust and legal liabilities (Previts & Merino, 1998).
By early 1985, it had become apparent to the accounting professions leadership that the
issues of financial management and fraud deterrence, and the expectations that various groups
had for the role that the accounting profession should play in addressing these issues, had to be
explored if the profession was to remain independent. The Treadway Commission, a private
sector commission established at the urging of the AICPA, would address this expectation gap
for the accounting profession (Tanki, 1992).
The final report of the Treadway Commission, issued in 1987, contained
recommendations for both the private and public sectors to improve financial reporting and to
deter fraud. Many of the commissions recommendations concerning independent auditors were
directed at closing the expectation gap between the public and the profession. The leadership of
the profession used these recommendations to approve and implement a series of expectation gap
standards including (Connelley, n.d.):
1. Amending the form and content of the standard audit report.
2. Redefining the auditors responsibility to detect and report errors, irregularities, and illegal
acts by their audit clients.
3. Recommended external auditor review of management reports on corporate internal controls.
4. Mandatory quality review for firms and auditors performing public company audits.
Although these standards were accepted and implemented by the accounting profession,
many accountants viewed this acceptance as merely symbolic. In many accountants minds,
management was still responsible for the financial statements and for any problems that arose
from their issuance. Designing audits to detect fraud was not just costly and ineffective given the
complexity of the modern corporation, but also risked increasing the firms legal liability if
something was missed, possibly increasing the risk of the firm being replaced due to audit cost or
creating management distrust of the audit process due to misunderstanding of the audit
objectives involving fraud detection (Previts & Merino, 1998).
The economic and financial explosion that occurred at the end of the 1980s and continued
through the 1990s caused the issue of financial statement fraud to fade much as the economic
expansion of the 1950s and 1960s had caused the issue to disappear. Everyone, including
investors and the government, accepted as fact that the current economic expansion was different
from previous expansions, with ordinary individuals gaining a fair share of the increased value of
the equity of corporations through their participation in the stock option plans of their employers,
IRAs, pension plans, and mutual funds. It was only in 2000, after the stock market continued on
the downward spiral and many Fortune 500 companies began to restate their financial statements
by billions of dollars, when people began to once again question the role of audits in preventing
financial statement fraud. Many reasons have been cited as to why corporations and corporate
executives commit fraudulent financial reporting. Among these reasons for fraudulent reporting
are executive compensation, personal greed, weak internal control, and lack of ethical value,
transition from cash base to equity base compensation, poor corporate governance, and conflict
of interest (Wells, 2005; Wolfe, 2004; Razaee, 2002).

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REASON FOR FRAUDULENT FINANCIAL REPORTING

Executive Compensation
One reason professionals have cited as the cause of corporate fraud is executive
compensation. The desire to achieve immediate success at all cost has led to lucrative
compensation packages for corporate executives. In 1990, the distribution of corporate executive
compensation was 92 percent cash and 8 percent equity. By the year 2001, this figure changed
to 34 percent cash and 66 percent equity. Not only did the distribution change, but the size of the
compensation also increased by more than 150 percent between 1992 and 1998. The problem
with the increase in equity compensation is that it forces management to engage in the kind of
manipulation that will increase the corporate bottom line and the basis of the company stock
(Wells, 2005).
Personal Greed
The second reason corporations and corporate executives commit corporate fraud or
fraudulent financial reporting is greed. Equity based compensation encourages CEOs to engage
in behaviors that will increase the corporate annual earnings, thereby increasing their personal
wealth. Most of these behaviors are accomplished through creative accounting and taking
advantage of loopholes imbedded in generally accepted accounting principles, and sometimes
through outright fraudulent financial reporting. Yet, the equity based compensation is far better
than the alternative which is the stock option plan. In 2005, the retiring CEO of Exxon-Mobile
received a golden parachute compensation plan worth $48.5 million. His compensation included
a retirement pension with a lump-sum value worth 98.4 million. By December of that year, the
CEO had accumulated $183.1 million worth of Exxon-Mobile stock and had options worth $69
million (Coffee, 2005). The problem with this type of compensation is that it encourages fraud.
The use of cash compensation is still the best option if the accounting profession is going to
reduce the issue of fraudulent financial reporting (Coffee, 2005; Manning, 2006).
Weak Internal Control
The third reason for the increase in fraud and fraudulent financial reporting is weak
internal control. By definition, internal control is a process put in place by management to
safeguard company assets from theft, misappropriation, and abuse. Ideal controls ensure
maximum separation of duties and prevent employees that have custody of assets from having
approval authority. But what happens when the management who put the control in place is the
one circumventing the control? Then you have chaos. The problem becomes even more severe
when there is collusion, which is usually the case with fraudulent financial reporting. The
greedy CEO must collude with the greedy CFO and others with decision making authority, to
make the fraud happen. As long as the message is coming from the top, everyone looks the other
way for fear of losing their job or being denied a promotion. Others simply do not care (Hall,
2001).

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Lack of Ethical Value

The fourth reason of increased of executive financial fraud is the lack of ethical value or
the degeneration of societal ethical value. Some have attributed this to the decline in religious
faith, the breakdown of the family structure, the rise of drug culture, the deterioration of the
education system, the impact of entertainment and internet society, and the role of the
government (Copeland, 2005). No matter the root cause of the problem, the lack of ethical value
is a serious societal concern as it relates to corporate fraud. Similar to the lack of ethic, is the
lack of corporate social responsibility. Each time a company fails as a result of the irresponsible
action by management, many lives are affected; and, the community as a whole is also affected
because both the community and the individual employees are stakeholders in the company.
Transition from Cash Base to Equity Base Compensation
The fifth reason for the rampant fraudulent financial reporting was the transition from
cash base compensation to equity base compensation. As mentioned earlier, this was the driving
force to increase the corporation bottom line, by any means necessary. The more profitable the
company is, the higher the corporate equity. The higher the stock value is, the higher the
corporate annual compensation. Those opposing this view point posit that removing equity
compensation or stock base compensation will stifle the CEOs drive to increase profit. Those
espousing this view claim that in a free market system, the corporate executive should be given
an incentive for innovative ideas and the use of ingenuity to increase profits. The downside of
this argument is that these corporate executives capitalize on this incentive for their personal
gain, to the detriment of the other stakeholders (Coffee, 2005; Manning, 2006).
Poor Corporate Governance and Conflict of Interest Problems
Finally, poor corporate governance and conflict of interest also increase instances of
fraudulent financial reporting. Members of the boards of directors of many Fortune 500
companies also belong to the same country clubs and serve together on the boards of many other
companies. The latter creates what is referred to as interlocking directorates or board overlaps.
This is a common practice and it is perfectly legal. However, the problem with such practices is
that it affects the quality of the boards decision making when voting for the compensation
package for another board member that serves with him or her in another company. It also
creates poor corporate governance and a conflict of interest problem. The lack of independence
affects the quality of the board members decision making process. As a result of these
situations, board members are approving compensation packages for each other based on their
relationships, and not based on the benefit to the company (Blum & Hoeffner, 2006). These
actions have been one of the major problems with many of the Fortune 500 companies. The
negative impact of the country club mentality is that there is no room to attract fresh blood and
fresh ideas to the corporate governance arena.
The impact of fraudulent financial reporting and corporate failure are felt beyond the
walls of the companies affected. The employees, the communities, the vendor, the investors, and
the bankers, to name a few, are impacted by such developments. In some cases, the government
steps in to control the downward trend in order to help restore public confidence in the market
and encourage optimism among investors. Amid crisis in the financial market, the government
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usually responds quickly with a stop gap measure. Following the stock market crash of 1929, the
Security and Exchange Act of 1933 and 1934 was enacted which eventually resulted in the
creation of the Security and Exchange Commission. In 2002, after the collapse of many
companies, the Sarbanes-Oxley Act was created (Blum & Hoeffner, 2006).
SARBANES-OXLEY ACT OF 2002
The same factor that had caused the fraudulent financial reporting in the early 1990s,
which was the increasing participation of small investors in the equity markets, now came back
to haunt the profession again. As more and more small investors experienced significant
decreases in their financial worth, they turned to the federal government with demands that
someone be held accountable for their losses, especially when it appeared that financial
statement manipulation was involved in their losses. (Yet, for the most part, the investors failed
to do the appropriate due diligence review before investing.)
The government responded with the passage of a significant piece of legislation, the
Sarbanes-Oxley Act of 2002, which was specifically aimed at the accounting fraud and the
fraudulent financial reporting. Sensing the significance of the need for change, the leadership of
the American Institute of Certified Public Accountants (AICPA) proposed its own changes to the
profession that were designed to reduce the incidence of financial statement fraud (Blum &
Hoeffner, 2006).
The problem with the AICPAs proposal was that it came too late. With the passage of
Sarbanes-Oxley Act, the profession lost its ability to self-regulate and to set auditing standards
and accounting principles. The profession had missed its chance to address the recurrent fraud
issues that had plagued the profession since its beginnings.
STANDARD SETTING AND THE POLITICS OF ACCOUNTING
As mentioned earlier, a cornerstone of the Sarbanes-Oxley Act is the establishment of a
Public Company Accounting Oversight Board (PCAOB). One of the boards responsibilities is to
establish or adopt rules concerning auditing, quality control, ethics, independence, and any other
standards related to audit report preparation (Glover, Prawitt, & Taylor, 2009) only for
companies listed in the New York Stock Exchange. This board was to cooperate with all current
standard setting groups, such as FASB, at least initially. The board, however, has the authority to
amend, modify, repeal, or reject any standards proposed by these groups if the board does not
agree with their findings. It is hoped that the PCAOB will be able to more effectively implement
standards that will make financial statements more transparent and useful to interested parties,
such as investors and company decision-makers (Glover, Prawitt, & Taylor, 2009). This will be
a dream come true judging by the success of the prior standard setters that have been created.
SUCCESS OF PRIOR STANDARD SETTERS
Although the mandate given to the PCAOB first appear to be a valuable and worthy goal,
the history of accounting standard setting bodies in the United States has not shown much
success. This lack of success is mostly the result of the political nature of standard setters.
First on the list was the American Institute of Accountant. The AIA established the
Committee on Accounting Procedure (CAP) (Previts & Merino, 1998) in 1939. One of the first
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issues debated by CAP involved the proper treatment of unamortized discounts on refunded bond
issues. The SEC, in an attempt to limit accounting alternatives, asked CAPs predecessor
organization, the AIA Committee on Cooperation, to determine the appropriate approach.
Unfortunately, this committee found support for all three theoretical approaches; amortization
over the life of the old bond issue, amortization over the life of the new bond issue, and direct
write-off to surplus (Previts & Merino, 1998).
Because of the prior failure to determine the best approach and limit alternatives, CAP
decided to address the bond discount issue as one of its first procedural problems. Unfortunately,
what was perceived to be an easily resolvable issue, turned highly controversial. It also
foreshadowed the difficulty the committee would have reaching agreements on many accounting
issues in the future (Previts & Merino, 1998).
Of all the treatments suggested, only one amortization of the discount over the life of
the new bond issue - was believed to have any theoretical merit. Most committee members,
however, did not want to debate theory, but to meet to discuss the SEC objective of limiting
alternatives. For this reason, the committee supported a direct write-off of the discount to
surplus. Since this theoretically led to distorted income, many accountants wondered what had
caused CAP to choose the least acceptable alternative. Many accounting theorists took CAPs
decision on the discount issue, and later the SECs acceptance of the distorted income
argument, as evidence that accounting standard setting had gone from an economic to a political
concept (Forsyth, Witmer, & Dugan, 2005).
CAPs successor organization, the Accounting Principles Board (APB) was to be
reminded of this political nature of standard setting in the early 1960s. Conceived of as a group
that would apply pure research into identifying the basic postulates and principles of
accounting, the boards Accounting Research Studies (ARS) and Accounting Principles Bulletins
(APB) were intended to limit alternative accounting procedures by reaching consensus among
practitioners on what constituted best practices. The problem for the board was its inability to
force practitioners to accept its recommendations. This became more of a problem when ARS
No. 1 and ARS No. 3 were rejected by most of the APB members and accounting practitioners.
In an attempt to force compliance with its pronouncements, the APB decided to use the threat of
an SEC takeover of the standard setting process if the profession could not reach consensus on
accounting standards. The APB assumed that the SEC, long known to want to limit accounting
practice alternatives, would support its action to limit alternatives (Forsyth, Witmer, & Dugan,
2005).
Unfortunately, the APB was to be undone by its supposed supporters. In the early 1960s,
the Kennedy administration, hoping to stimulate capital investment, conceived the idea of the
investment tax credit. The problem created by this credit for the accounting profession was the
lack of consensus among practitioners about the proper accounting treatment of the credit.
Hoping to quickly settle the issue, the APB published Accounting Principles Bulletin No. 2,
which required the use of the matching instead of the flow through method in recognizing
the credit. This resulted in the dilution of the immediate economic, as well as political, benefits
of the credit (Previts & Merino, 1998).
The reaction was immediate. Corporate managers complained to Congress, which being
motivated to improve the economy and share in the political credit for its improvement, listened
attentively. When several of the Big Eight accounting firms announced that they would not
follow APB No. 2, the government saw its chance to act. The SEC, which was expected to
support the APB on this issue, instead supported the accounting firms that rejected APB No. 2,
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citing substantial authoritative support for alternative treatments of the credit, including the
flow through method of recognizing the credit (Previts & Merino, 1998).
This decision to not require SEC registrants to follow APB No. 2 sent a very strong
message to the APB -- Accounting theory or technical preferences would not be allowed to
overcome political objectives. It also rendered the APB ineffective in handling subsequent
controversial accounting issues since it was always possible that the board would be overruled by
politicians if corporations believed a required accounting treatment could be unfavorable to
them. This ineffectiveness of the APB indirectly contributed to the perceived abusive reporting
practices that occurred during the merger mania of the late 1960s (Schroeder, Clark, & Cathey,
2001).
By the early 1970s, it became apparent to many in the accounting profession that the
APB needed to be replaced. The Wheat Committee, formed by the AICPA in 1971, represented
the professions major attempt to maintain its standard setting abilities, while acknowledging that
user groups of financial statements were much more diverse than in the past. This
acknowledgment had political implications for both any accounting standard setting body and the
profession itself. It became apparent that to meet its new and expanding societal and political
responsibilities, it would be necessary to enforce, through revision of the AICPA Code of
Conduct, the requirement that all AICPA members employ any standards promulgated by the
professions standard setting body, unless doing so would result in material financial statement
misstatement (Previts & Merino, 1998).
The standard setting body that emerged from the Wheat Commissions deliberations, the
Financial Accounting Standards Board (FASB) began operations in 1973. It originally consisted
of seven full-time public accounting based CPAs. FASB was envisioned as a board that would
allow all user groups with an interest in financial statement standards, not just CPAs and
corporate management, to provide input into the standard development process. This objective
was accomplished by allowing all user groups to comment on FASB proposed changes and draft
final proposals before FASB released the finished standard as official GAAP. (Previts &
Merino, 1998).
By 1991, FASB had issued more than one hundred standards. The creation of the
Emerging Interest Task Force in 1982 added to the increasing number of standards being issued,
by resolving less critical issues using a less formal process based on practitioner consensus.
Although generally considered a success in meeting its original objectives as a standard setter,
even FASB could not avoid the chief problem of earlier standard setting bodies -- politics. This
became very clear in FASBs handling of the stock option compensation disclosure issue (Previts
& Merino, 1998).
FASB had studied the stock option disclosure problem for many years. In 1993, it
released its Exposure Draft of Statement of Financial Accounting Standard No. 123. This draft
sought to measure and account for compensation expense resulting from employee stock option
plans using a fair value framework and option-pricing model that (Schroeder & Schauer, 2008)
estimated the fair value of the options and required its disclosure as compensation expense on the
financial statements of the granting corporation. Initially, many practitioners and interested
parties, including politicians, supported this draft (Grant & Ciccotello, 1995).
This support quickly became opposition when certain industries, such as the computer
and software industries, expressed their opposition to the draft. Corporate leaders from these
industries, along with other industry leaders, expressed their displeasure with Draft No. 123 to
Congress through the Financial Executives Institute. The result was a bill sponsored by Senator
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Joseph Lieberman that mandated that the SEC block the reporting of compensation from stock
options. Although not passed, the bill should have sent a clear message to FASB -- option
expensing was a political, as well as economic, issue. The problem was FASB seemed to fail to
get the message (Grant & Ciccotello, 1995).
In late 1995, FASB tried again to issue standards for disclosure of stock option
compensation expense. This time the Financial Executives Institute opposition actually resulted
in the SEC threatening to take over the financial standards setting process, without the usual
benefit of public hearings, due process, funding review, and so forth. This forced FASB to
abandon the requirement that accountants follow the exposure draft. Instead, FASB
recommended that accountants follow the guidance provided by the draft voluntarily (Grant &
Ciccotello, 2002).
The threatened takeover of the professions standard setting body also convinced the
Financial Accounting Foundation, the group with ultimate control over FASB, to take a much
more public interest profile when it came to accounting issues and standard setting. FASB had
finally recognized the political nature of standard setting (Previts & Merino, 1998).
The implications for the new Public Company Accounting Oversight Board should be
obvious. Although it is to be responsible for standard setting, the old enemy of prior standard
setting bodies, the SEC, will still have ultimate control over accounting standards, even if only
indirectly, through its approval of PCAOB board members.
Other evidence exists that politics will continue to play a major role in standard setting.
Even though many individuals and statement users believe that stock options played a significant
role in the accounting frauds that occurred in the early 2000s, initial demands for a stock option
expense disclosure amendment to the Sarbanes-Oxley Act by Senators Levin and McCain were
sidetracked. Instead, Senators Enzi and Lieberman offered a bill requiring only a study of the
issue by the SEC and FASB. Although eventually it was established by the SEC that stock
options would be expensed, history shows that the political climate of the time, rather than the
appropriateness of the accounting theory being developed, dictates whether or not an accounting
standard is adopted. The lesson to be learned by the PCAOB from these examples is that
standard setting does not exist in a vacuum. Failure to recognize the political, as well as the
economic consequences of standard setting, will usually lead to failure of the standard setting
bodys success (Fogarty, 1992).
HOW DID THE ACCOUNTING PPROFESSION BENEFIT FROM THESE
SCANDALS?
It is conceivable to argue that the accounting profession is a reactionary profession. The
profession reacts to changes taking place in the economy as it relates to company financial
management. Most of these changes have in many ways influenced the development of the
profession. After the stock market crash in 1929, the government enacted the Security and
Exchange Act of 1933 and 1934. The latter led to the creation of the Security and Exchange
Commission. The process of revitalizing the economy also led to the New Deal policy. The
combination of these actions further fuels the continuing need for accounting services.
The Wheat and the Trueblood Committee were both formed to look into the development
of new accounting standards and regulations. This need came about due to the collapse of several
companies during the 1960s and 1970s.

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Student Enrollment Increase

Prior to the year 2000, there was a gradual decline in student enrollment in accounting
programs. This was because college students, particularly the African-American student, viewed
the accounting profession as a boring profession, lacking the charisma, fame, and fortune
associated with other professions such as law and medicine. Unlike doctors, lawyers and other
high profile professions, the accounting profession and professionals rarely exhibit public
persona. Young people knew very little about the profession. Scandal brought the accounting
profession to the limelight. High school students began to see accounting and the accountant as a
cool profession. Enrollment increased as more students became aware of the role of the
accountant in the community. The increase in the starting salary for an entry level accountant
also helped (Ross & Traub, 2008; Earley & Kelly, 2004).
New Curriculum in School
Scandal was also a wake-up call for educational institutions to develop an ethics course
as part of the accounting curriculum. Many arguments have been raised as to whether ethics or
morality can be taught in college. The answer to that question is a story for a different paper, but
suffices to say that bringing the issue of ethics to the awareness of the student before they go into
the work force is good enough. The result is that almost every accounting curriculum in most
colleges and universities today includes ethics as part of the curriculum (Earley & Kelly, 2004;
Karr, 2004).
Business Generated from the Scandal
In addition to the increased enrollment and publicity enjoyed by the profession as a result
of the scandal, there was also more business created from the regulation enacted by the
government to deal with the aftermath of the scandal. Sarbanes-Oxley Act required internal
control review and compliance by all publicly traded companies. These reviews created new
opportunities for public accounting firms. Also, the independence requirement of the Act created
other types of services by spreading the work to more firms. Companies were given more of an
opportunity to outsource their services to different firms rather than allowing a firm who
performed their audit to also provide consulting services for the company (Karr, 2004).
AFTERMATH OF THE LATEST SCANDAL
Creation of Sarbanes-Oxley Acts
In the aftermath of the latest scandals, there was a loss of public confidence in the
financial market. The stock market plunged amid peoples fear of losing their nest eggs. To
restore public confident, the United States Congress responded to the crisis by passing sweeping
legislation that imposed the strictest government oversight on the accounting profession since the
creation of the 1933 and 1934 Acts in the 1930s, known as the Public Company Accounting
Reform and Investor Protection Act of 2002 (popularly called Sarbanes-Oxley Acts of 2002).
Congress created the Public Company Accounting Oversight Board (PCAOB to oversee the Act.

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Creation of PCAOB
Similar to the reason leading to the creation of the Security and Exchange Commission,
the Act of 2002, also led to the creation of the Public Company Accounting and Oversight Board
(PCAOB). This board is charged with the responsibility to oversee the new act. The board
consists of five members and operates generally under the supervision of the SEC. These
regulations are directed towards public companies listed in the New York Stock Exchange.
The Act gave the five member board the authority to investigate and penalize accounting
firms that perform a substandard audit for publicly traded companies. The Board does have
further authority to set accounting standards with the approval of the SEC. In addition, they have
the authority to perform annual audits of any accounting firm that performs and issues financial
reports for more than 100 public companies (Meyer, 2005).
Sarbanes-Oxley Act of 2002, as the Act is traditionally called, was signed into law to
improve corporate governance and oversight of the accounting profession. The most
controversial part of this Act is the change from industry self-regulation and enforcement of
standards relating to auditing, accounting, control, ethics, and independence, to essentially,
government regulation. The Act limits the types of non-audit services that a public accounting
firm can provide to audit clients. The objective of the Act as mentioned earlier was two-fold:
First, to restore public confidence in the ailing securities market; and secondly, to prevent future
corporate fraud. The latter seems like wishful thinking because prior to the corporate scandals,
there were many elements of Sarbanes-Oxley Act already in place. The failure of corporate
gatekeepers to abide by these rules and regulations put in place through the Security Acts of
1933 and 1934 was more to blame for the scandal, and not the lack of regulations (McEnroe,
Stevens, & Hill, 2005).
OBSERVATION
When the Security Act of 1933 and 1934 was enacted, SEC was given the power to
regulate the accounting profession and standards. This authority was deregulated to regulate
itself. The failure of these corporate giants under such self-regulation is a signal to the SEC that
the profession is not capable of self-regulation unless it changes its image from a reactionary to a
proactive profession.
Giving the responsibility to regulate or oversee PCAOB to the SEC might be another
mistake on the part of the government. A better process would have been to make the PCAOB
independent of the SEC, but to require collaboration directly with the SEC with regard to
standard development. When a new standard is created by the PCAOB, the SEC should comment
on the standards just like any state CPA Society or other interested party. These comments are
therefore taken into consideration when preparing the final Standard.
BENEFIT OF THE NEW ACT
Investors
The public and investors benefit from this new pronouncement because the Acts make
financial statements more transparent. The public confidence is also enhanced through improved
board and committee participation in the operation and control process. Improvements in the
internal control also protect the assets of the organization from intentional and unintentional
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abusers. Requiring management certification of annual audits improves accountability and

eliminates a claim of ignorance. Accounting firms will think twice before getting involved with
management over improper implementation and will consider the public, the investors, and other
stakeholders (Anonymous, 2003).
Practitioners
Practitioners also benefit from this pronouncement because the new Act increases
outsourcing for internal control review as well as compliance review. Compliance with Rule 404
of the Act means hiring a consulting firm to perform the engagement (Anonymous, 2003).
DISADVANTAGES OF THE NEW ACT
Trickle Down Effect
The biggest losers in the new pronouncement are the small companies and small
accounting firms. Small companies will have problems generating enough funds to comply with
the new rules. Although the Act was specifically designed to regulate public companies rather
than private companies, it has had a trickle-down effect on small companies as well as small
accounting firms. Independent provisions of the Act mean that small firms will have problems
servicing their small clients because of the non-attest services. Some of the small companies
serviced by small firms will have problems paying two accounting firms to perform these
services (Grusd, 2004).
Cost
The cost of compliance with the Act is astronomically high and many companies are
having problems complying with the requirements. There is also a knowledge base requirement
which involves training employees on the implementation of the new Act and the accompanying
internal control requirements (Gienke, 2008).
RECOMMENDATION FOR FUTURE REREARCH
In the future, perhaps researchers should focus on empirical review of the relationship
between the scandal, the aftermath, and the financial meltdown in the global economy. Although
the Sarbanes-Oxley Act is still new, future research will be needed to evaluate the impact of the
Act on corporate governance, the impact on corporate morality, and whether the introduction of
ethics in academic curriculum helps reduce fraudulent financial reporting.
CONCLUSION
Throughout the history of accounting and the accounting profession, fraudulent financial
reporting has been present. Scandals are neither new to the profession nor will Enron, Tyco, or
WorldCom be the last of this embarrassing trend. The sound of the word scandal bares
negative connotations to the profession. However; on the other hand, the profession has
generally received some benefits from the scandals. It has help increase the visibility for the
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profession, as well as increased student entrance into the profession. The scandal was also the
impetus that led to the creation of one of the most sweeping reforms in the accounting industry,
the Sarbanes-Oxley Act. This Act attempted to help put a brake on the dwindling public
confidence. As with every regulation, Sarbanes-Oxley Act came with some good and bad
ramifications, but none more dramatic than taking the regulation of public companies accounting
standards from the profession and giving it to the government through the creation of PCAOB to
regulate standards for public companies.
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About the Author:
Augustine Enofe earned his Doctorate in Business Administration (DBA) with a concentration in accounting from
Argosy University, Sarasota. Dr. Enofe is an Adjunct professor of Accounting at Argosy University. He is a
Certified Public Accountant and a Certified Fraud Examiner.

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