Recently, accounting professionals have been placed under immense pressure by changes in the size and scope of financial markets. The primary means of communicating the financial effects of organizational activities and transactions of a company to outsiders is the financial reporting system. This reporting system includes communicating financial information through various forms such as a prospectus, forecasts, annual reports, and other financial releases. Financial statements are the main source of information conveyed to external parties.
The reporting process is a means of “increasing the trust placed by investors, lenders, and others in the entities with which they deal. The financial reporting process itself relies on trust of its users, and this trust has been threatened due to unreliable and deceptive accounting reports” (Whittington, 1999, p. 3). The difficulty in securing reliable information may be most apparent when “a manager’s compensation is directly tied to accounting based performance measures. Since these measures are generated inside the firm, essentially by the same group of people whose decisions are driving the business performance, the opportunity for manipulation is present” (Weinberg, 2003, p.5). Financial reporting is designed to meet the needs of users by providing information that is relevant to making rational investment and credit decisions, and other informed judgments (Marshall, 2004, p.18).
The relationship among the SEC, FASB, and PCAOB
Does fraudulent financial reporting represent the Achilles’ heel of the U.S. Corporate
Financial market? Accounting scandals are not new. Episodes of fraudulent accounting have occurred repeatedly in the history of the U.S. Financial markets. The SEC, FASB, and PCAOB were established to provide government enforcement of corporate honesty.
The relationship among the SEC, FASB, and the PCAOB is that these agencies:
* Provide leadership,
* Establish standards and rules governing the operation of
* Improve accounting principles, and
* Objective is to ensure sound financial reporting
“In the aftermath of the stock market crash of 1929, public attention and congressional investigation led to allegations of unsavory practices by some financial market participants during the preceding boom” (Weinberg, 2003, p.5). This activity led directly to the creation of the Securities and Exchange Commission in 1934. One of the founding principles of this agency was that companies publicly offering securities for sale in interstate commerce must tell the public the truth about their business.
In the early 1970’s as with today, accounting problems raised concern within the accounting profession. To settle the critics the Financial Accounting Standard Board (FASB) was created and began work on the Conceptual Framework Projects. In addition, the FASB developed the Generally Accepted Accounting Principles (GAAP) along with the SEC, AICPA, and GASB. These concepts provided the general accounting principles to be followed when preparing financial statements” (Ng, 2004, p. 3). The FASB is the official rule-making body of the accounting profession. The FASB’s mission is to establish, improve, and maintain independent standards of financial accounting and reporting.
The year 2002 was one of great tumult for the American corporation. The accounting and auditing standard-setting processes have been heavily criticized because of Enron’s collapse. Bankruptcies, fraud, unethical and deceptive reporting problems from other companies such as TYCO, WorldCom, and Global Crossing have stimulated widespread scrutiny of accounting policies. In July 2002, President Bush signed into law the most significant legislation affecting the accounting profession, the Sarbanes-Oxley Act. The act created a five member Public Company Accounting Oversight Board (PCAOB), which has the authority to set and enforce auditing, attestation, quality control, and ethic standards for public companies. The PCAOB is also “empowered to inspect the auditing operations of public accounting firms that audit public companies as well as impose disciplinary sanctions for violations of the board’s rules, security laws, and professional auditing standards” (Ng, 2004, p. 3).
Explanations of basic accounting theories, assumptions, and principles
Accounting theory is a set of basic concepts, assumptions, and related principles that explain and guide the accountant’s actions in identifying, measuring, and communicating economic information. The major underlying assumptions or concepts of accounting are business entity, going concern, substance over form standard, and money measurement (unit).
Business Entity – data gathered in an accounting system are assumed to relate to a specific business unit or entity. The business entity concept assumes that each business has an existence separate from its owners, creditors, employees, customers, other interested parties, and other businesses (www.ventureline.com).
Going Concern – accountants record business transactions for an entity assuming that a business will continue to operate indefinitely.
Substance Over Form Standard – emphasizes the economic substance of an event over though its legal form may suggest a different result.
Money Measurement (unit) – stipulates that all business transactions must be expressed in money terms (dollars). The concept that each accounting period has an economic activity associated with it and that the activity can be measured, reported, and accounted for.
GAAP has four basic principles: The Historical Cost, Revenue Recognition Principle, the Matching Principle, and the Full Disclosure Principle. The Historical Cost requires companies to account and report based on acquisition costs rather than fair market value for most assets and liabilities. The Revenue Recognition Principle requires recording revenue when revenue is realized and earned not when cash is received. The Matching Principle expenses have to match with revenues. “The logic underlying this principle is that whenever economic resources are used someone will want to know what was accomplished and at what cost” (Ng, 2004, p. 3). The Full Disclosure Principle is information that is important enough to influence the decisions of an informed user of the financial statement should be disclosed. In addition, the information disclosed should be enough to make judgment while keeping costs reasonable.
An evaluation of the role of ethics in accounting
Society has high expectations concerning accounting professionals. More than ever, accountants need professional values and ethics that allow them to operate successfully and with integrity in a changing world. “With so many people both externally and internally relying on financial statements for decision making, accountants above all others are obligated to conduct themselves in a manner consistent with the highest ethical standards” (Marshall, 2004, p. 14). Practitioners of accounting have an obligation to the public, their profession, the organization they serve, and themselves to maintain the highest standards of ethical conduct. The AICPA released the following statement; “Our profession has zero tolerance for CPA’s who do not adhere to the rules” (Keim and Grant, 2003, p.1). Accounting has long been a rules-based profession. However, in today’s environment, is mastery of and conformity with the rules sufficient for the practice of accounting? Pincus (2000) said, “Human decision makers tend to treat prescriptive rules as definitional-that is, they tend to treat rules as determining how a game is played, rather than as guidelines for right behavior. They tend to become rule-bound, rather than rule-guided”.
Accounting is an integral part of human society. It is important to realize that accounting is more than just a mere technical subject; accounting is determined by the context in which it operates. In particular, it is contingent upon history, country, technology, the nature and type of the organization. In order to appreciate accounting practice properly, we need to understand the regulatory and conceptual frameworks within which it operates. Essentially, understanding accounting is a prerequisite for understanding business. I believe the key to accounting is proficiency, liability, integrity, and trust.
About the Author
Anola Love is an employee of Georgia-Pacific in Atlanta, Georgia in the Accounting department. She has a BA degree from Dillard University in New Orleans, Louisiana. In addition, Anola has a MBA degree from the University of Phoenix, Atlanta Campus.
Anola has experience in preparing, analyzing, interpreting, presenting accounting information, and applying accounting principles. She believes the key to accounting is proficiency, accountability.