Earlier in the decade, financial scandals revealed that third party consulting firms could not be trusted to guarantee impartial results when delivering internal business audits. Friendly business relationships where these consultants handled both audits and general accounting created a massive conflict of interest where the accountants were now put into a situation where they could not only be pressured to fudge the numbers a bit, but it was even to their own advantage. The lucrative consultancy contracts began affecting the decisions made in audits. Accounting firms were being asked to measure the results of companies and projects where they had a personal stake, which removes any aspect of independence for a third party audit.

Easily the best example of this occurred in 2001 with the Enron and Arthur Andersen scandal. Even today, many people do not realize exactly how massive this scandal was – unless they were investors. Enron was one of the top ten largest companies in the entire world. Arthur Andersen was one of the big five accounting firms and arguably the most recognizable name in the entire industry. In order to manipulate its own stock price, Enron was hiding its debt in subsidiaries (or even reporting it as profits in some cases) which artificially inflated its net profits. This is a situation that should have been revealed by audits, yet Arthur Andersen never reported anything. In fact, it was revealed that the firm actually went to great lengths to help Enron in its deceit. When the house of cards fell (as it always does), both companies would be taken down and cease their business operations. Perhaps the greatest irony in this situation is that the real Arthur Andersen who founded the firm in the early twentieth century was a stickler for standards and honest practices. To have his beloved firm go under by putting the wishes of Enron’s management above that of their investors must have turned him over in his grave.

Beyond Enron’s own unethical behavior, the biggest problem in this situation was the conflict of interest where accounting firms could use their audit operations to leverage their consultancy departments. While every publicly traded company has an auditor to cover its finances, who is auditing the auditors? Whose job is it to make sure that the auditing party is acting ethically and independently? Unfortunately, this answer to this question is still a bit murky. Following the Enron collapse and subsequent Worldcom bankruptcy, the United States passed the Sarbanes-Oxley act (commonly referred to as SOX). This added a great number of reforms that theoretically should hold the accounting industry to much higher standards than ever before put to paper. However, detractors still argue that it was filled with loopholes. It is up to the accountants to behave ethically and not step through them, but ethical accountants were never the problem in the first place.

With regards specifically to the potential conflict of interest before mentioned, SOX and subsequent laws has put a limit on the services accountants can provide. Auditors can no longer provide non-audit services (such as consulting) to a client. It is believed that, should a situation like Enron occur again, a truly independent auditor will not be as likely to ignore massive deceptions in a balance sheet with only their own department at stake. However, how well auditors hold themselves to this standard remains to be seen.

Author Bio: By Felix Chesterfield; The preceding article deals with a subject that would be aided by software audit tools, to learn more about this topic, please contact the author.

Category: Business
Keywords: Financial scandal, audit, accounting