MBA: 8 Accounting Scandals and Their Impact on the Profession

Here’s my MBA assignment. I also completed a quiz and a one-page paper you don’t see. (And cover photo courtesy of Pixabay, free of charge).

1. In 1931 Lord Kylsant who was the chairman of the Royal Mail Steam Packet Company and Mr Morland, the Company Auditor were charged with publishing a false and fraudulent balance sheet (a statement of the assets, liabilities, and capital of a business or other organization at a particular point in time, detailing the balance of income and expenditure over the preceding period). They created an impression that the company was ‘solvent’ and healthy from normal operations, when in fact, it had a loss of £300,000 and not a profit of £439,000. This was particularly pertinent because it was indebted to the government (tax payers) for a £10m loan. This ‘accounting scandal’ touches upon the criticism about using ‘secret reserves’ to shore up the financial statements of companies. This practice before the ‘advent’ of modern account theory was thought prudent and upheld business privacy in the late 19th Century. During the 1920’s ‘too many’ companies took advantage of this practice that it rendered financial statements, as an ‘informational by-product’ of accounting useless and even detrimental to good decision making. However both men were acquitted because of the historic precedence of secret reserves and practically no change came of this incident especially it being the eve of the Second World War. source: http://eprints.bournemouth.ac.uk/3074/1/296.pdf

2 & 3. In the late 1960s (1967) two major consumer companies were caught reporting profits when they had losses. The post-war consumer until then was confident in the modern era of accounting, perhaps due to the adoption of practices in the UK of those in America, that helped harmonise the accounting of conglomerates to give a holistic financial picture to stakeholders. The two companies that broke accounting law were Rolls Razer and Associated Electrical Industries. Press comment naturally condemned this, stating that for the investor ‘the case is yet another reminder that accounting figures, by their inherent nature, fall into the category of the relatively true rather than the absolutely true’ – which is failing to provide a faithful and relevent reflection of the company operations through its financial statements, that is the service of accounting. And though the financial statement of one of these companies (Rolls Razer) was said to be “‘more informative than most’. It was not the quantity of information that was lacking, but evidently (lacked) the quality.” This runs counter to the usefulness of accounting, which is for financial statements to be faithful and relevent, not merely faithful but irrelevent. It is reminiscent of the accounting scandals in America, where executives used ‘conservative estimations’ to alter the perception of their companies to external users of financial statements. These two incidences criticizes the Institute of Chartered Accountants for its inefficiencies with regard to ‘policing this attribute – ‘it is inevitable that room for differences of opinion will remain’.

4. In 1969, two years later, a company called Pergammon Press was to be sold to a US company, Leasco. When the deal was called off because Leasco, the US company was not provided with the information it requested a Board of Trade investigation revealed profits that were ‘hidden away’ and not given over in Pergammon Press’s financial statements, meaning not included in the deal. Once again the press critized the professions lack of commonsense judgement. “the Economist was one of the foremost critics of the profession, attacking it for relying on ‘integrity and commonsense, guided by occasional statements issued by the various professional institutions to back up the information and method of presentation required by the Companies Act’.” What was missing? It seems accounting as a service wasn’t serving everyone but just a select few. What was happening here was reminiscent of accounting in the 19th century, when books were kept only for investors and the companies ‘cash transactions’. This case highlighted the lack of consideration in the modern economy, of other parties, like new owners, employee groups and the community as represented by regulators, as well as the profession that wanted to be more trustworthy.

The point so far, is that would these executives be ‘going to battle’ with the numbers they were reporting if they kept these companies. And the answer is no, failing the ability to make good future decisions by potential buyers and other people with a non-transactional stake in these deals, including employee groups and regulatory planners. As a result, “In December of 1969, as an attempt to remedy these problems and prevent such intervention, the English Institute of Chartered Accountants published ‘A Statement of Intent on Accounting Standards’” clarifying that an ‘honest’ accountant is in service that is faithful, relevant, neutral, complete and free of error. Such that the information can be used by everyone to make ‘good’ decisions.. “commented that the importance of this development could be ‘likened only to the inauguration of the Institute’s series of recommendations a quarter of a century ago.’”
http://www.icaew.com/en/library/subject-gateways/accounting-standards/knowledge-guide-to-uk-accounting-standards

5. In 1990 Polly Peck’s founder-CEO Asil Nadir, a British conglomerate that began as a small textile company but was now a giant in electronics, fruits and packaging, was convicted of fraud. Polly Peck was ‘legendary’ for its humble beginnings to being a company on the FTSE 100 with a market capitalization of over $1 bn. Assisting him and also charged were three auditors in Northern Cyprus who reported ‘fictional’ figures relating to the companies divisions in that region, significant because Mr. Asil Nadir funnelled corporate funds into divisions in Northern Cyprus for ‘fictional or false’ corporate dealings that ultimately landed in personal accounts controlled or guardianed by him. https://www.theguardian.com/business/2003/may/01/7
https://en.wikipedia.org/wiki/Polly_Peck

6. In 2010, Equitable Life Assurance Society, a life insurance company, ‘closed shop’ after a judgement by the House of Lords was in favor of one of its policy holder. The judgement ruled that their internal practices of ‘promising’ higher rates of return paid out annually on life insurance policies, when in fact they were using the revenue from one type of policy to finance the higher returns on a different type of policy – ‘a pyramid scheme’ (I dare say) when the high-return policy was to be a ‘market-rate play’. It highlights the role of other stakeholders to financial statements like the insurance regulatory authorities and the consumer, who reported the company when return on their policy did not perform as expected if it had been a ‘market-rate play’ as sold.
https://en.wikipedia.org/wiki/List_of_corporate_collapses_and_scandals
https://en.wikipedia.org/wiki/Equitable_Life_Assurance_Society_v_Hyman

7. “MG Rover was put into administration in 2005 with debts of 1.4 billion pounds and the loss of 6,000 jobs. Four of its directors – the “Phoenix Four” – set up a company to buy the loss-making carmaker for a token 10 pounds five years earlier.” Deloitte, an accountancy firm, was charged and fined by the British government, for not considering public interest – “for failing to manage conflicts of interest. Deloitte had acted as corporate finance advisers to firms involved with MG Rover and the Phoenix Consortium”. Deloitted allowed tax losses from MG Rover to be transfered to another company held by the ‘Pheonix Four’..meaning a company like that holding company that purchased MG Rover for 10 pounds was now benefiting extraordinarily from ‘unearned or costless’ tax losses. Why is it in the public interest, that is the community at large? MG Rover, a major employer, wouldn’t have properly benefited from tax loss credit and reprieve. In this scenerio, because of the precarious state of MG Rover and its employment creation in the community, Deloitte displayed ‘conflict of interest’ acting as auditior and financial advisor to MG Rover and the ‘Pheonix Four’ without equal regard to ‘community representatives’. It was allowed to repeal the amount of fines but not the charge itself.
http://en.wikipedia.org – MG Rover Group – Wikipedia

8. “Northern Rock had invested in the international markets for sub-prime mortgage debt, and as more and more people defaulted on their home loans in the US, the Rock’s business collapsed. It was ultimately sold to Virgin Money (r. Virgin Mobile, Virgin Radio and Virgin Airlines).” The bank borrowed heavily in order to finance mortgage loans to consumers. It would then resell these ‘long term’ debt obligations in order to make its money back in the immediate present. Unfortunately, sub-prime mortgage holders began defaulting and the appetite for what the bank was reselling (known as ‘securitised debt’) began to wane. It wasn’t able to repay the interest on its initial borrowing and it wasn’t able resell more of these securitised debt that were based on sub-prime mortgage products. Though not an accounting scandal, it touches on the high-risk behavior in banking and raises the question about the public’s tolerance for risk..that the bank should embark on this strategy while servicing all types of customers, including those with low-risk tolerance. The greater regulatory environment then becomes an adherence for the accountant.
https://en.wikipedia.org/wiki/Northern_Rock