There have been a number of business scandals that came as a shock to the business world including the famous Enron scandal 2001, Waste Management scandal 1998, Tyco scandal 2002, WorldCom scandal 2002, Lehman Brothers scandal 2008, and so on. There always seems to be a temptation to manipulate or misrepresent financial information when it involves a large sum of money. There is an Italian proverb “Big mouthfuls often choke” which appropriately represents such temptations and their outcome. Creative accounting is the term used for the process of intentional manipulation or misrepresentation of financial data, especially within financial statements. The process itself is not as simple as it sounds and involves complex practices for the purpose of under-reporting earnings or liabilities, over-stating revenues or assets, and mismanaging & misusing funds, and others.
Here is a list of top ten Accounting Scandals of the 21st century – Figure 1(wallstreetmojo.com):
21st century has seen the worst of the business scandals in history. The scandals resulted in the loss of billions of dollars which destroyed the whole companies and lives of thousands of people. Some of these scandals have been the deeds of a group of people while others due to a few individuals only. These individuals or what we refer to as creative accountants will always come up with novel and innovative ways to manipulate financial data and figures to the company’s advantage. The purpose is simple; to make the company look successful and profitable. It is worth mentioning that such practices are unethical but not illegal because they are used by the company without violating the rules. Various creative accounting techniques are used by the companies to distort the true and fair view of the financial position of the company resulting in serious corporate failure.
Let’s look at some of the major Accounting Scandals:
Enron Scandal of 2001:
Enron Corporation, a well-known American company, was an energy, commodities, and service company. The company was considered to be one of the successful companies in the late 20th century. It was in the year 2001 when it was found that the company had been using creative accounting techniques to not only hide billions of dollars of debt but also to inflate the earnings of the company. This resulted in the collapse of its share price from $90 to less than $1 within one year and consequently the shareholders lost over $74 billion.
An investigation was initiated by Securities and Exchange Commission (SEC) and it was found that the CEO of the company, Jeff Skillings, and former CEO, Ken Lay, had indulged in unethical practices of keeping billions of dollars of debt off the balance sheet. Later it also came to light that company’s auditing firm also ignore the issue. The scandals lead to the bankruptcy of the company. Prosecutor Andrew Weissman indicted all the individuals involved in the scandal including both the CEO’s and the entire auditing firm Arthur Anderson.
Lehman Brothers 2008:
We all have heard the name ‘’Lehman Brothers’’, one of the largest investment banks in United States at the time. The accounting scandal of the company came to light in the year 2008 during the financial crisis. It was found out that the company hid over $50 billion in loans. Lehman Brothers collapse is considered to be the largest bankruptcy in the history of United States with the company holding over $600 billion in assets in 2008.
Through the process of ‘creative accounting’, Lehman were able to classify short-term loans as sales and then use the cash proceeds from these ‘sales’ to reduce its liabilities in time for the year-end financial report. After the reports were published, Lehman then borrowed cash and repurchased its original assets. Using Repo 105, Lehman was able to artificially reduce its balance sheet by $50 billion.
Put in simple words, the biggest motivator for companies to indulge in creative accounting is the ‘’competitive market’’. The same practices were followed by Enron Corporation and Lehman Brothers which lead to the collapse of the companies. This is because of such practices that the Accounting Standards were modified and made stricter to help prevent creative accounting practices. The government has also to play a crucial role in creating entrepreneurial friendly environment which will help prevent creative accounting practices by the companies.