The collapse of Enron has cast great fear in the hearts of many investors. Within a matter of weeks, billions of dollars and thousands of jobs have vanished. The worst thing is that investors are losing faith in the US corporate accounting system, and in Arthur Andersen, which is among the five largest accounting firms. Many investors are wondering whether there would be another possible "Enron" firm out there, in which the firm and its auditors have similar problems with their accounting standards. Without reform of the current relationship between a client and the auditing firm, it is very possible that there are some other firms out there, which have a similar if not worse situation than Enron has.
At the moment, a firm would usually have a long-term relationship with its chosen "outside" accounting firm. What that means is that a firm would hire accountants who are not the firm's employees to do the firm's auditing. Often, if the firm (the client) is pleased with the auditor (the accounting firm), they would hire them for long periods of time. Such a long-term relationship means long-term business for the accounting firm. Thus, a lot of money! For example: in 2000, Arthur Andersen earned $25 million in auditing fees from Enron, with an additional $27 million for consulting fees. Thus the company earned $52 million from Enron alone. With so much money in stake, sometimes it becomes very tempting for the auditors to please the clients with their desired number games. Sometimes, as long as the client pays them well, the auditors would pretend not to see weak spots or problems in their clients' balance sheets.
Here are some of the biggest accounting failures over the last few years:
Oct 1995: Bausch and Lomb overstated income by $17.6 million and settled the lawsuit
for $42 million.
Nov 1999: Rite Aid overstated revenue by $1 billion
Dec 1999: Cendant overstated income by $500 million through fraud and accounting errors.
May 2001: Sunbeam was charged by the Security and Exchange Commission (SEC) for accounting fraud, while Arthur Anderson settled a shareholders law suit for $110 million.
June 2001: Waste Management overstated earnings by more than $1 billion between 1992 and 1996. Arthur Anderson agreed to settle by paying $229 million to shareholders.
Nov-Jan 2001: Enron scandal.
A possible solution? Mandate rotation of auditors.
One possible solution is for the US government to pass a law in which US firms are required to change their auditors once every 5 years or so. With that requirement in place, auditors would be much more conservative with their clients' balance sheets, since in the near future, a competing auditor would be checking the balance sheets, and would be willing to point out bad auditing mistakes.
Unless the current system is reformed, investors will continue to lose faith in auditors, and consequently, so will their appetite for US investments.
Wilson Siu is a --- majoring in economics.
