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Accounting
shenanigans at Enron and WorldCom make a case for revisiting
the US GAAP. Is a switchover to principles-based accounting
standards desired?
Who
knows it better than Enron? Before its disgraced collapse,
who had thought that cooking-the-book (inflating accounting
numbers) could be perfected to such an extent that it no longer
remained just that plain vanilla accounting. Instead it had
taken the form of an art. Malicious executives fudged accounting
numbers, fooled shareholders, markets, and perhaps everybody
else including regulators. Innumerable cases of accounting
shenanigans have literally inundated Wall Street in a short
span in recent times. Enron cooked its books by exploiting
the loopholes in the existing accounting statements on SPEs;
Qwest Communications got around by channel stuffing its revenues
by recognizing its future sales as current year revenues.
WorldCom willfully misstated earnings by capitalizing operating
expenses. At Adelphia Communications, it was a case of concealing
huge sums of loans given to the company's promoters. While
at Tyco, it was a case of the company bearing the million
dollar lavish lifestyles of its chief executive.
While FASB (Federal Accounting Standard Board), the body which
frames the standards for the US accounting industry is still
struggling to grapple with the loopholes in standards, there
is increasing pressure on it to adopt the principles-based
approach to set accounting standards. Principle-based standards
provide broad guidelines without being voluminous, at the
most they contain 10-12 pages compared to hundreds of pages
that characterizes the US GAAP. While some in the investor
fraternity and competitors like IASB are pressing the FASB
to go for it, a word of caution on principle-based approach:
they lead to interpretations and, in many cases, misinterpretations,
if the skeptics are to be believed. Given this, will it be
a wise move to espouse the principle-based approach?
While
there are no doubts that the recent cases of accounting shenanigans
highlight the laxity of auditors and their conflicts of interest,
experts suggest that the problem runs much deeper than what
was initially believed. Over the years, business dynamics
have changed and so have the way companies do their business.
However, one thing that hasn't changed is the way financial
statements are presented. The emergence of knowledge economy
has significantly tilted the scale in favor of intangible
assets. Intangibles like Human Capital, Customer Capital,
Trademark, Goodwill, Patents have come to account for a significant
portion of a company's asset base, still they find either
little or absolutely no recognition in the financial reports
of a company.
Another
critical development, which the accounting rule setters have
been slow to respond to, is accounting for stock options.
Abuse of stock options at companies like Enron and WorldCom
which on one hand made their executives filthy rich, while
millions of their employees and shareholders lost their hard
earned money as these companies' inflated share prices crashed
to ground zero. The deafening silence of the rule makers has
meant that millions of investors across the globe are kept
in the dark as to what the actual cost of operations of companies
is. A recent study done by S&P shows that there is a huge
difference between a company's reported earnings and its actual
earnings on the basis of its recently introduced metric Core
Earnings (see table - Inflated profits).
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