In 2001, Enron Corporation went into bankruptcy due to the disclosure of false information in its financial statements. Similarly, when Lehman Brothers collapsed there was no evidence that it had ever publicly disclosed certain detrimental accounting information.
Cases of accounting fraud such as these have become increasingly serious. Accounting fraud can result in creditors and stockholders losing confidence in listed companies, which negatively affects the whole worldwide economy.This paper will briefly analyse some of the causes of accounting fraud in listed companies, and then examine and evaluate three possible solutions to address the situation. First, it will argue that the main cause of accounting fraud in listed companies may be the intentional manipulation of financial statements by management to avoid negative disclosures to the public.
Then the three possible solutions offered are the improvement of corporate governance structures, the independence of the certified public accountant (CPA), and the strengthening of laws and regulations governing public supervision of accounting information.It is generally considered that modern accounting systems provide strong protection for the rapid development and success of an enterprise, especially for listed companies. Especially, in the decades after World War 2, accounting discipline and practice ushered in rapid growth in the developed countries over the decades that followed. Multinationals and listed companies have gradually adopted modern accounting systems for financial accounting and transactions.In addition, in order to fit their operating strategies, listed companies can adjust their presentation form as desired, or use selected information to report a better-looking financial statement, on which credit rating agencies mainly depend to derive their credit rating scores. Since investors sometimes rely heavily on these ratings to make investment decisions, a relatively effective and orderly financial market is crucial for the prosperity of the stock market.
The main reasons for accounting fraud in listed companies can probably be ttributed to attempts by management to hide adverse information and overstate profits on financial reports. By so doing they hope to attract more investors and maintain stock prices. Therefore, the monitoring of company management is one of the fundamental purposes of accounting. As a result, managers may be held responsible for the accounting fraud committed by their accountants. For example, WorldCom Group overstated its pre-tax income by at least $7 billion, the biggest accounting fraud in history at the time (Kaplan & Kiron 2004), while in China; YinGuangXia falsely claimed enormous profits of $13 billion.A second reason for accounting fraud might be insufficient and less independent audit reports, sometimes omitting necessary procedures and even failing to provide an independent, third-party opinion about the financial position of a company in pursuit of maximum profit due to fierce industry competition.
Finally, a lack of effective and traceable mechanisms within listed companies and accounting firms can enable them to cheat investors and governments.One possible solution is to optimize corporate governance structure by reducing the level of stock-based compensation of company executives in a listed company. Listed company usually award executives of this company with shares if the company has anr outstanding performance in one year. As a result, when the managers’ wealth contains a high proportion of stock-based compensation, they may be tempted force accountants to commit accounting fraud to raise the share value of their companies.In this way, it could bring more profits and ownership to these executives who prize personal short-term gains over firms' long-term health. Erickson (2006) finds that while the unconditional likelihood of accounting fraud is small, an increase in the stock-based proportion of compensation by one standard deviation increases the probability of accounting fraud by approximately 68%.
Indeed, while executive stock options play a positive role in the management of a company, according to some empirical evidence (Hanlon et al. 2003), managers may use option grants for their own benefit (Aboody ; Kasznik 2000; Yermack 1997). The above research indicates that reducing the proportion of stock-based compensation for managers can help reduce the incidence of accounting fraud. However, the granting of stock options in low level for company executives may affect their working enthusiasms.
The most commonly cited advantage in granting stock options to managers is that they increase managers’ loyalty and commitment to the organization, and managers become owners with a financial stake in the company's performance (Hillstrom 1999).Moreover, higher level of stock-based compensation helps reduce tax to companies which are not having the need of recording options pending as an expense until stock options are exercised by executives. This evidence points out that the listed company could provide more stock options to executives to motivate their talent and potentiality to enhance the company's profits. Improving the independence of auditors might be another effective way to exert control over accounting fraud. This may be achieved through both ethics education for university students and continued ethical training for auditors.
Bean and Bernard (2009) point out that to retain or improve their level of independence and respect, CPAs should become active proponents of ethics education, both in the initial education of those entering the profession and in ongoing professional education. Han (2005) argues that at present ethics education is virtually nonexistent in the accounting profession in China, and that, therefore, it is necessary to establish and improve the profession’s ethics education. In United States, the importance of ethics is being minimized by its curriculum’s refusal to integrate ethics as required courses (Bean ; Bernard 2009).Based on these arguments, ethical education in accounting for university students could be essential for improving independence when these students work as CPAs in the future. In addition, the boards of accountancy in at least 26 states in the USA require CPAs to pass an ethics exam or course, either before sitting for the Uniform CPA Examination or as a condition of certification (Ronal ; Hirschwailer 2009).
Based on this evidence, continuing ethical training for auditors plays a crucial role in improving the independence of auditing.Some scholars believe that strengthening laws and regulations regarding public supervision of the accounting system is the ultimate way to solve this problem. This includes establishing an audit case appraisal committee and raising standards for determining accounting fraud. Generally, current auditing standards have such high requirements that a court would struggle to define inappropriate or even illegal behaviour among auditors due to the degree of specialization required in this field. For this reason, it is essential to set up an audit case appraisal committee led directly by the Securities and Futures Commission.
Furthermore, its appraisal reports should be legally valid as direct evidence in a trial. Its main purpose would be to ensure that a company and its president pay a high price for falsification. In addition, raising the standards for determining accounting fraud is an effective precautionary measure to stop accountants or auditors who try to evade detection. Even though a listed company may not have intended to commit fraud, it can still be held responsible for accounting fraud by the Securities and Futures Commission.For example, 72% of Chinese accountants who were involved in accounting fraud said they did not do so intentionally (Xi, 2006). This evidence shows that raising standards in detecting accounting fraud may improve public supervision of the accounting system.
However, this may also negatively affect the economy. Overly strict accounting supervision may cause a situation where listed companies dare not make a definitive move. It will undoubtedly limit the creativity of companies and their sensitivity to the market if employees focus too much on avoiding negligence when dealing with any statement related to accounting.In conclusion, the problem of accounting fraud in listed companies has become one of the most serious issues all over the world. The major contributor to this problem is the management’s desire to conceal adverse information in accounting reports and to overstate profit.
Therefore, an optimization with the governance structure in corporations is the critical factor in preventing accountants from providing false information. Based on some evidences, an establishment of criteria to differentiate auditing from consulting work could be implemented to solve the problem of accounting fraud.Moreover, improvement of independence of auditors could also play a part in decreasing the risks of accountants’ fraud. However, it is important to remember that too much oversight on accounting may result in ignorance of operation at some degree.
Therefore, management of a company, accountants, auditors and even the public are all responsible for seeking solutions for the problem of accounting fraud. Only with a combination of all these organizations might this problem be solved.Referencehttp://www.referenceforbusiness.com/encyclopedia/Eco-Ent/Employee-Stock-Options-and-Ownership-ESOP.htmlhttp://ministers.treasury.gov.au/DisplayDocs.aspx?doc=pressreleases/2001/077.htm;pageID=003;min=jbh;Year=2001;DocType=0
