The Shift toward a Global Economy: Changes in Accounting Regulations to Repair a Broken Past and Lay a Solid Foundation for the Future

With the growth and development of a much more dynamic business market, many companies have seen opportunities to expand and profit. However, this has also led to much confusion over which specific regulations and entities should dictate how businesses should report and act. The Financial Accounting Standards Board and the International Accounting Standards Board have been working concurrently to provide a consistent standard that can be applied universally. Though there are many differen ces between the frameworks of the two organizations, compromises are being made to suit the general business realm. The recent recession has also caused problems for the business world, and has put an even greater urgency on the need for reform and revisions. With the collapse of Enron in 2001 and the passage of the Sarbanes-Oxley Act, accounting regulations have take n a step in the right direction, but these changes will not automatically solve a ll problems within the industry. Ethical education and universal enforcement also need to be emphasized to cut down on corporate greed and dishonesty to ensure that another economic meltdown will not occur in the near future. THE SHIFT TOWARD A GLOBAL ECONOMY 4 The Shift Toward a Global Economy: Changes in Accounting Regulations to Repair a Broken Past and Lay a Solid Foundation for the Future The History of Expansion and Accounting Within the United States Over the past few centuries, the world has been shrinking. Perhaps not in a litera l sense, but through advances in communication and transportation, it is easier to navigat e. As a result, new opportunities have developed that would never have seemed feasible in the past. Trade between nations has increased exponentially and businesses have bee n forced to adapt. Multinational corporations like Coca-Cola and McDonald’s have flourished by stretching themselves to reach markets that have not yet been e xposed to similar industries (Kristensen & Morgan, 2007). In an attempt to gain a portion of these emerging markets, some small businesses look to investors as a way of quickly raising capital and expanding. However, if i nvestors want to feel secure in a particular venture, they should pay special attenti on to he financial statements and earnings records of the company in which they plan to i nvest. The problem that this presents is that regulations between nations can sometimes vary greatly. This not only poses a dilemma for investors, but also for the business worl d in general. Gaps within the standards can lead to earnings manipulation and dishonest reporting, which leads to even greater distrust toward the industry. The Securities and Exchange Commission (SEC) was created in 1934, with the authority to oversee accounting practices of publically traded companies in the U i ed States and regulate the securities and trading markets (Spiceland, Sepe , Nelson & Tomassini, 2009). Throughout the history of the US, numerous regulating bodies have been established to take the place of the previous bodies to meet the needs of the THE SHIFT TOWARD A GLOBAL ECONOMY 5 increasingly complicated business world. The American Institute of Certi fied Public Accountants (AICPA) was the first organization to deal specifically wi th accounting matters and did so from approximately 1936-1959 (Facts, 2009). Currently, the Financial Accounting Standards Board (FASB) oversees accounting regulations within the U i ed States while the International Accounting Standards Board (IASB) deals wi th international affairs. To provide added guidance, the FASB has established a conce ptual framework and Generally Accepted Accounting Principles (GAAP) to assis t in decision making. The IASB also has a conceptual framework for companies to follow, but has no formal organization to enforce these regulations (Spiceland, et al., 2009). This pr esents a problem for some multinational corporations as well as for investors that are inter ested in financing foreign companies. A universal standard helps to ease some of these iss u by ensuring consistency of practice throughout the industry and improved, centraliz d enforcement. The Joint Conceptual Framework Project is a collaboration of membe rs from the FASB, the IASB, and various other countries’ representatives (Lian, 2009). With so many differing ideas and opinions about how standards should be set, some compromises must be made. Another reason for the call for a set of uniform standards is the mistrust of the public in regards to the financial stability of the economy and certain financial institutions. Over the past few decades, certain businesses have been at the f orefront of conversation when discussing financial misfortunes, including Enron, Adelphia, and WorldCom. Even the present financial situation has roots in the need for universality and continuity of accounting standards. Dishonest sub-prime lending and gross misst atements of income have caused the housing market to deteriorate at a rapid rate and the general THE SHIFT TOWARD A GLOBAL ECONOMY 6 stock market declined substantially as a result (Kiviat, 2007). The government spons ored enterprises Freddie Mac and Fannie Mae received governmental subsidies to a ssi t the lower income borrowers and thus began giving out loans with higher than average interest rates to account for the increased risk. These loans were then pooled and sold t o investors as mortgage backed securities. Though this temporarily helped to incr ease home ownership and the value of the housing market, it was unsustainable and collapsed when the individuals could not afford to pay the high interest costs and began to default on the loans. This over-valuation in the mortgage backed securities led to a severe col lapse that many people blamed on the accounting treatment of Freddie Mac and Fannie Mae and the loans they were providing (Jaffee & Quigley, 2008). If the public cannot trust le nders and banks or the value of their own homes, then how can they trust big businesses that only seem to care about their bottom lines? The passage of the Sarbanes-Oxley Ac t has helped to address many of the issues within the United States, and through the work of the Financial Accounting Standards Board and the International Accounting Standards Bo on the Convergence Project, the accounting profession will undergo some serious changes from a global perspective and not only emerge stronger, but also better equi pped to prevent and deal with dishonest reporting and inadequate internal controls. Enron and the Sarbanes-Oxley Act One of the prime examples of suspect accounting occurred during the late 1990s and early into the 21 st century at Enron. However, the fault does not lie solely with the management and internal reporting; financial auditors and regulators have al so taken a fair share of the blame and were a catalyst for the passage of the Sarban es-Oxley Act (SOX) in 2002 (Reinstein & Weirich, 2002). THE SHIFT TOWARD A GLOBAL ECONOMY 7 The name Enron was not always associated with scandal; in fact, prior to its collapse, Enron was a respected and seemingly prosperous company. Initially an e nergy supplier and distribution company, Enron found success as a pioneer in the emerging market of deregulated energy and eventually expanded to include various other industr ies including energy brokerage and derivative trading (Reinstein & Weirich, 20 02). In early 2001, Fortune magazine acknowledged Enron as the “Most Innovative Large Company” for the sixth straight year in its annual survey of “Most Admired Companies” (H ealy & Palepu, 2003, p. 3). The problems began when the inflated expectations of stockholders could not be met and the company began to utilize Special Purpose Entities (SPEs) as a way to diversify risk and appear to investors as financially viable (Schwarc z, 2002). Though in principle SPEs are legally permissible, many of the SPEs connected wi th Enron were controlled by managing executives and served as a source to hedge funds a nd risk. With a personal interest in the success of these SPEs, a significant a mount of management within Enron began to face conflicts of interest. The transactions between the parent company, Enron, and the SPEs essentially amounted to internal transfers that helped to inflate their profit to an embellished and unsustainable level (Healy & Palepu, 2003). The corruption was so widespread throughout the company that even when the company’s vice president, Sherron Watkins, approached the CEO Kenneth Lay and the Board of Directors and said she was “incredibly nervous that we will implode in a wave of accounting scandals” (Reinstein & Weirich, 2002, p. 22), her concerns were ignored. This lack of internal control and indifference to wrongdoing eventually led to Enron’ s downfall. THE SHIFT TOWARD A GLOBAL ECONOMY 8 While it is easy to condemn the actions of Enron’s management, their auditing firm Arthur Anderson and the governing bodies that regulate these events are jus t s much at fault for their failure to deal with the illegal behavior. The purpose of havi ng these checks and balances in place was to assure the investors that the financial statements are reliable and that they have been prepared accurately. Characteristically, the professional gatekeeper essentially asse sse or vouches for the corporate client’s own statements about itself or a specific transaction. T h s duplication is necessary because the market recognizes that the gatekee per has a lesser incentive to lie than does its client and thus regards the gatekeeper’s assurance or evaluation as more credible. To be sure, the gatekeeper as wat chdog is typically paid by the party that it is to watch, but its relative credibil ity stems from the fact that it is in effect pledging a reputational capital that it has built up over many years of performing similar services for numerous clients. (C offee, 2002, pp. 5-6) Yet with corruption and dishonest accounting practices so prevalent within the indu