Bankruptcy: Its Prediction and Accounting Indicators
One major assumption in accounting is the Going Concern. It states that an accounting entity is viewed as continuing in operation indefinitely, thus, financial statements are normally prepared in the assumption that the entity will continue its operations for the forseeable future. But then it is inevitable that one shall come to an end. So if there is evidence that the entity’s operations are to be terminated, the going concern assumption is abandoned. There are several reasons behind the cessation of an entity’s operations. Bankruptcy is one of them.
Predicting bankruptcy is of essence to a business. As much as possible, a business will do everything just to escape bankruptcy and to still continue the normal operations of the business. The owners, management, the accountants, auditors, and everyone who has interest in the business should be aware of the different factors and indicators of a near-bankruptcy.
After the high-profile corporate collapses in 2001, bankruptcy and accounting fraud became critical issues that should be addressed in the corporate world. This led the researcher to the topic Bankruptcy: Its Prediction and Accounting Indicators. The story of Enron is what made the researcher very interested in the topic. The Enron scandal, revealed in October 2001, eventually led to the bankruptcy of the Enron Corporation, an American energy company based in Houston, Texas, and the dissolution of Arthur Andersen, which was one of the five largest audit and accountancy partnerships in the world. In addition to being the largest bankruptcy reorganization in American history at that time, Enron undoubtedly is the biggest audit failure.
Young as I am, I dreamt of putting up my own business and investing in capital markets. It is important that I should learn everything that may occur in a business, may it be positive or negative. And when the time comes that my own business shall experience bankruptcy, at least I already know what to do. Bankruptcy occurs when firms lack sufficient capital to cover the obligations of the business. The bankruptcy process begins with a petition filed by the debtor (most common) or on behalf of creditors (less common). All of the debtor's assets are measured and evaluated, whereupon the assets are used to repay a portion of outstanding debt. Upon the successful completion of bankruptcy proceedings, the debtor is relieved of the debt obligations incurred prior to filing for bankruptcy (Ball, 2000). In the case of Enron, its stock price dropped from $90 per share in mid-2000 to less than $1 per share at the end of 2001, caused shareholders to lose nearly $11 billion. And Enron revised its financial statement for the previous five years and found that there was $586 million in losses. Enron fall to bankruptcy on December 2, 2001.
The revelation of accounting irregularities at Enron in the third quarter of 2001 caused regulators and the media to focus extensive attention on Andersen. The magnitude of the alleged accounting errors, combined with Andersen's role as Enron's auditor and the widespread media attention, provide a seemingly powerful setting to explore the impact of auditor reputation on client market prices around an audit failure.
This story of Enron and Andersen should be given emphasis by all accounting students and accounting professionals. As students, we were taught of the Code of Ethics. And as professionals, they should continue upholding these ethics in the practice of their profession. The topic Bankruptcy: Its Prediction and Accounting Indicators would familiarize accounting students and professionals on the accounting indicators when a future bankruptcy shall occur. With this, when students become professionals already, they can identify and recognize signs of bankruptcy, and shall warn and give advice to the firm they are working with.
Also, as accounting students and future professionals,...
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