Noble Accounting, or Accounting Nobles? - The Government Created Accounting Fiasco

Noble Accounting, or Accounting Nobles?
THE GOVERNMENT CREATED ACCOUNTING FIASCO
Second of Three Parts
by Ted Lang

July 3, 2002

Columnist Ted Lang Accounting practices and techniques had very noble beginnings, considering their establishment in the aura of enlightenment marked by such intellectual giants as Leonardo da Vinci and Johann Wolfgang von Goethe. How could such a noble profession, comparable to that of medicine and law, have fallen so low in public esteem?

To answer this question, I ask the reader to consider how the other professions have likewise been compromised. Consider the corrupting influence of government meddling and interference, and the corrupting influence of its political players. Politicians do not serve in the public interest – the serve themselves first, foremost and always. Their motto is, and always has been, The public be damned!

The complexity of corporate finances, investing, intangible property valuations such as goodwill and patents, along with considerations of international law and changing government entities, as well as the complexity of goods and services resultant of rapidly changing technologies, has clouded financial performance measurement and investment issues relating to corporate America. Responding to the complexities of business, so-called benign government intervention is sought by those who advance confidence in government oversight and policing to protect investors, creditors, employees and pension plans.

As was previously pointed out in the first installment, financial statements, the income statement and the balance sheet, are key to understanding the business performance of a publicly traded corporation. To protect stockholders from swindle, the government created the Securities and Exchange Commission [SEC] to monitor financial reporting as well as to watch over investment offerings and ratings. Part of that monitoring effort on the part of the SEC, is the requirement by publicly traded corporations to file its periodic financial reports in formats identified as 10K and 10Q reports. Additionally, concurrent with the financial statement reporting required by the SEC, the government’s Internal Revenue Service requires the filing of periodic tax returns based upon revenue levels as well as payroll withholding tax filings.

Between the SEC, IRS, and now the additional dimensions of government "oversight" in the Equal Employment Opportunity Commission and both state and federal environmental agencies, both the cost and complexity of business have skyrocketed. The SEC and IRS make it mandatory that the periodically released financial statements submitted to them are first audited by independent, professional, certified public accounting firms to attest to the accuracy and substance of the statements issued and their conformity to "Generally Accepted Accounting Principles" [GAAP].

CPAs are licensed and certified by the states, and CPA firms must be controlled by senior and managing partners so licensed. CPA firms cannot incorporate – they can only expand by adding partners along with their rank and file staff of employees. In this regard, liability is assured as with other professional associations reflective of law and medical professional associations.

CPA firms have membership in the professional association identified as the American Institute of Certified Public Accountants, or AICPA. This equates to the Bar Association or the American Medical Association. Accounting principles, GAAP, are controlled and reviewed the Financial Accounting Standards Board [FASB] of the AICPA. In this manner, the licensing of individual CPA firms, as well as the self-policing professional requirements of the AICPA and the FASB-control of GAAP, the American public is supposedly protected from stock market fraud and swindle. CPAs watch themselves, corporate financial statements and reporting, and the Government in terms of the IRS and the SEC watches everybody.

So what happened? First Enron, then Global Crossing, then K-Mart, WorldCom, Xerox, Martha Stewart – what’s going on? With the exception of the Martha Stewart issue, which is precisely the same issue as the appearance of insider trading regarding Hillary Clinton and Terry McAuliffe, all the rest are the result of bribe-giving and bribe-taking under the guise of campaign contributions and "lobbying." It is influence buying and influence peddling, and the victims are as always, the American people.

The chairman of the SEC under Clinton, Arthur Leavitt, tried to establish legislation that would prevent public accounting firms from acting as both independent auditors as well as management consultants and advisors to the same client. The obvious conflict of interest creates an environment where the accounting firm is motivated to assist the client in achieving wealth by, how shall I put this, "helping" the client avoid disparaging financial scenarios on the financial statements required by the SEC.

Additionally, as the income statement lists revenue and expense from operations for the purpose of showing whether the business made a profit or a loss for a specific period, and the balance sheet shows only static values of asset costs matched against loans and other borrowing arrangements in order to determine net worth, technically camouflaged accounting entries that transfer liabilities off the balance sheet to phantom subordinate corporations, and deliberately show revenue or expense recordings in the wrong period, create false and fraudulent information.

Enron maneuvered liabilities off their balance sheet and placed the credits on the books and statements of other phantom businesses not included in their reporting to the SEC and IRS. WorldCom recorded expenditures [outlays of cash] as capital expenditures [asset purchases], instead of operating expenditures [expenses]; therefore the charges [debits] appeared on the static balance sheet instead of the statement of operations, or income statement. Expenses reflected on the income statement reduce profit and by not showing expenditures to the tune of $3.8 billion, misled the SEC, IRS, and the public.

Another accounting trick used, this one by Xerox, could be best described as deliberately misphasing revenue reporting. Businesses use the accrual method of accounting as opposed to the cash basis we use for our personal financial management and to file our tax returns. Accrual accounting recognizes and records revenue when it has legally been earned, and can justify a lawsuit for collection. Conversely, expenses are recorded the moment they can be legally enforced against the reporting entity. Xerox failed to distinguish revenue changes from outright sales to longer-term lease collections, thereby concentrating revenue within a shorter time frame.

In the next installment, we examine how our government is complicit in all this. ***

Photo of Columnist Ted Lang courtesy of the author