Analyse the Problem of Accounting Fraud in a Listed Company and Evaluate Possible Solutions

Topics: Employee stock option, Finance, Accountant Pages: 5 (1784 words) Published: January 25, 2011
Analyse the problem of accounting fraud in a listed company and evaluate possible solutions

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 attributed 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...
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