Accounting Regulations: Corporate Failures and Changes

This research report investigates the influence of corporate failures on accounting standards and regulations, focusing on the cases of Enron and Lehman Brothers and their impact on the development of accounting standards. The report examines how these corporate crises led to changes in fair value accounting, including the classification and measurement of assets and liabilities. It also highlights the increased political influence on accounting standard-setting after the global financial crisis. The report discusses improvements in accounting regulations due to corporate failures, the role of IASB, and the impact of political lobbying. It analyzes specific examples of political influence in the US, Australia, and globally, and the development of the Sarbanes-Oxley Act and IFRS 9 in response to corporate scandals and financial crises. The study also explores the evolution of accounting practices and the role of regulatory bodies in ensuring financial reporting accuracy and reliability.

Accounting Theory & Contemporary Issues
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Executive Summary
This research report has been developed for examining the influence of corporate failure
on causing changes in the accounting standards and regulations. The corporate failures of Enron
and Lehman Brothers have been examined in relation to measuring the impact of the downfall of
these corporations on the accounting standard development process. These corporate crises are
regarded to be associated with causing changes in the accounting standard relating to the use of
fair value accounting. The changes in relation to the classification and measurement approach for
assets and liabilities under the fair value accounting have been introduced in response to the
global financial crisis. In addition to this, the report has also inferred that political influence on
the accounting standard-setting process has been increased post the global financial crisis.
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Contents
Introduction.................................................................................................................................................4
Improvement in the Accounting Regulations due to Occurrence of Corporate Failures.............................4
Literature review on the evaluation of political process of accounting standard setting............................7
Section A: Discussion on the lobbies or influences on the political lobbying or influences in the process
of accounting standard setting................................................................................................................7
Political lobbying examples with specific context to Australia, US and Global level................................9
Conclusion.................................................................................................................................................10
References.................................................................................................................................................11
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Introduction
The IASB (International Accounting Standard Board) is responsible for the development
of accounting standards and regulations for monitoring and controlling the financial reporting
practices of corporations. The application of relevant accounting standards and regulations
ensures the reliability and integrity of financial reporting for the investors. It has been identified
in this regard that the occurrence of the corporate scandals leads in improving the accounting
regulation and standards by overcoming the shortcomings in the accounting practices that are
responsible for the occurrence of the crisis. The report has evaluated this aspect in detail by
providing relevant arguments and also emphasized in detail about the influence of political
context in the accounting standard-setting process.
Improvement in the Accounting Regulations due to Occurrence of
Corporate Failures
As per Akpotu (2013) the corporate failures of the businesses can be regarded as a major
threat for sustained economic growth around the globe. The era of 2000 have witnessed a large
number of corporate failures such as Enron, Worldcom and others have mainly occurred mainly
due to the global recession witnessed in this financial period. The major reason for the downfall
of these business corporations is the due to use of unethical accounting practices that lead to
manipulation of the accounting information. The corporate failure of Enron and Worldcom have
occurred mainly due to the use of fraudulent and unreliable accounting practices that lead to
development of manipulated financial results. For example, Enron, an American energy
company that collapsed in the financial year 2001 mainly due to use of fraudulent accounting
techniques. It has been identified by the SEC (Securities Exchange Commission) that the use of
sophisticated accounting practices has been adopted by the company to increase its share price,
raising investment against its own assets and stock and developing a false impression among its
investors regarding to being a successful company. The accounting techniques that have been
used by the company can be regarded as aggressive earnings management accounting practices
that resulted in depiction of its higher profitability position and subsequently leading to increase
in the share prices. Enron depicted increase in its investment money from its partnerships even
though the ventures are not being carried out (Akpotu, 2013).
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According to Li (2010) it adopted the use of special purpose entities for hiring its losses
and reporting higher profits by depicting lower debt in its financial statements. All these false
accounting practices are used by the company for improving its credit rating and transferring
risk. It adopted the use of off-balance sheet method for concealing its losses and restating its
earnings proper to the period. This misuse of off-balance sheet method by the company has
resulted in causing the need for providing additional disclosures within the financial statements.
In addition to this, the use of mark-to-mark accounting practices resulted in reporting of
unrealized gains within its income statements. Also, it has violated the Generally Accepted
Accounting Principles (GAAP) by manipulating the derivates by the use of fraudulent
accounting practices which resulted in hiding its losses in the derivative section (Li, 2010).
The occurrence of such type of corporate failure has led to the development of Sarbanes-
Oxley Act in the year 2002 to improve the fairness and financial trusts among the major publicly
traded companies. The act has been developed to promote integrity in the financial reporting
processes of corporations operating within the US market. The business entities operating within
the US are required to comply with the act for ensuring that the financial information presented
to end-users is free from any type of error. The act has required the need for companies to
provide adequate disclosures regarding their off-balance sheet transactions and also about any
significant material changes in the financial statements that can have an impact on the financial
position of companies. The act has also mandated companies to audit their financial statements
in a regular manner for identifying any issue that can negatively impact the financial reliability
and accuracy (Goelzer, 2019).
Lemus (2014) have stated that the SEC commission of the US has led to the development
of this act for implementing necessary changes within the accounting rules and regulations. The
act has also resulted in the development of Public Company Accounting Oversight Board
(PCAOB) for the purpose of monitoring and controlling the audits of public entities. It has
resulted in imposing of several work responsibilities to the auditors to ensure that the financial
reports developed by business corporations are free from any type of materialistic error. In
addition to this, the occurrence of large number of corporate scandals in the era of 2000 have
also resulted in causing the need for SEC to adopt international standards on accounting, that is,
IFRS, for improving the accuracy of the financial reports. As per the European Commission
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(EC), the European Union should adopt some common rules in compliance with IFRS to
overcome the deficiencies in their current accounting reporting practices
Similarly, Masoud & Daas (2014) have stated that the occurrence of financial crisis of the
year 2008 that lead to failure of major banking corporations around the world such as Lehman
Brothers, Merrill Lynch, Royal Bank of Scotland and many others have raised the concerns
regarding the use of fair value accounting practices. The fair value accounting practice shave
been criticized since the occurrence of corporate failures of the era of the financial year 2008 and
are largely believed to causing the collapse of several bank institutions during the respective
period. The fall of Lehman Brothers in the financial year 2008 has put pressure on IASB to limit
the scope of the fair value principle. This was because the use of such accounting practices for
valuation of financial assets and liabilities has resulted in depicting their inaccurate valuation.
This is because the bank assets are valued on the basis of collective forecasts relating to future
returns to be realized from the market. Thus, in the event of occurrence of mortgage crisis in the
year 2008 it was rather very difficult to assess the fair market value of asset and liabilities. Thus,
it has been identified in the occurrence of crisis situation that value of bank assets is significantly
less as compared with the values reported. This resulted in crashing the share price of many
banking financial institutions during the period of crisis and thereby losing the faith of the
investors (Bengtsson, 2011).
The occurrence of such corporate scandals have resulted in causing pressure on IASB for
causing changes in the accounting rules and policies relation to the use of fair value accounting
measurement approach. The EU has put pressure on the IASB for limiting the type of assets that
are subjected to be valued with the use of fair value measurement approach. This caused IASB to
adopt necessary changes within its accounting standards relating to the use of fair value
accounting practices of IAS 39. The IASB has developed new accounting standard IFRS 9 for
providing guidance in relation to methods adopted for classifying and measuring financial asset
and liabilities (Sherman & Yound, 2016).
The standard has stated an entity should recognize a financial asset or liability in the
balance sheet only when it becomes party to the contractual provisions of the instrument. The
new accounting standard has provided new valuation criteria for determining the expected losses
and stated new rules that are being used for derivates recognition. The occurrence of the global
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financial crisis has highlighted the weakness in the current accounting standards and thus became
a subject for valuation by the regulatory bodies. The regulatory bodies after evaluation of the
causes of the occurrence of the corporate failures during the time of global financial crisis have
stated the changes required in the accounting standard of IAS 39. The main objective behind the
instruction of accounting standard of IFRS 9 is to reduce the occurrence of such financial crisis
in the future context. Therefore, the weakness of fair value accounting model that resulted in
causing the occurrence of corporate failures has been overcome with the introduction of new
accounting standard of IFRS 9 that regulates the use of fair value measurement approach
(Giroux, 2008).
Literature review on the evaluation of political process of accounting
standard setting
Section A: Discussion on the lobbies or influences on the political lobbying or
influences in the process of accounting standard setting
There are two international recognized accounting bodies that govern the process of
accounting standard setting and they are IASB and FASB. IASB refers International Accounting
Standard Board and FASB refers to Financial Accounting Standard Board, former has primary
objective of make regulations & standards at global level within the framework of IFRS
Foundation and successor has primary objective to establish and improve the Generally Accepted
Accounting Principles in United States. Both of these bodies work for the promotion of public
interest through modifying and issue of new accounting standard. It must be noted that IASB is
previously known as International Accounting Standards Committee (IASC) and in year 2001,
IASB has been formed to carry forward the job of IASC. There were little or no political
influences on the process of standard setting and governance of IASB but the global financial
crises has changed the way political parties look at accounting standard. Now political parties
take accounting standard as the most important factors that has caused the financial crises at the
global level (Chatham Larson, Vietze, 2010).
Bengtsson (2011), in his article reviewed how the European Union has used its power to
influence the process of accounting standard setting and response of IASB to limit the influence
of EU. The finding of this research indicates the global financial crisis is main reason that has
contributed to the repoliticalization (Role of political bodies) in the process of accounting
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standard setting. Before crises there has been no or moderate influence of political bodies on
IASB but after crisis position was changed and there was rebalancing of power as political
bodies have gained the influence over the IASB as the expense of other parties. Research has
even mentioned that EU has gain power to influence the normal accounting standard process of
IASB and governance structure.
Another important research has been conducted by Ahmad (2015) for explaining the
concept of lobbying and its occurrence occurred in the global context. As per the research study,
purpose of political lobbying is to change the outcome of the standard setting process in order to
provide benefit to the specific group of industries or any other personal benefits. Political
lobbying is carried at very big level and there are many players involved in the whole process. It
is not possible that lobbying can take place without the support of political parties. The lobbying
helps to increase in the economic value of specific industry and also helps the group of people to
achieve the self interest which is not aligned with the IASB and FASB objectives. Political
parties make pressure on the accounting standard board and force them to make decision in their
favor.
Further, the author has stated that the objectives of conceptual framework is also get
impacted as primary objective of the conceptual framework is to allow the accounting standard
board to make the accounting standard that does not favors the particular section of the society
and promotes the investors interest. The major disadvantage of political lobbying occurs on the
group of people unintentionally suffered the impact of particular standard that might be corrected
if there was no political influence over it. For example, a method of inventory valuation can be
profitable for the specific group of people but at the same time it will cause loss to other parties.
Author has highlighted the mission of IASB and FASB that get impacted due to political
lobbying within the accounting standard setting. These missions are (a) to provide the accounting
standards that are more aligned with the definitions of the items of the financial statements as
they these definitions are developed looking at the economic context or value they are delivering,
(b) to improve the transparency in the accounting process and (c) to eliminate the choice of
accounting methods that promotes the flexibility in accounting process and provide the benefits
to the specific people of society. But due to political intervention it is not possible and these
entire mission get hampered only to provide advantage to specific people (Ahmad, 2015).
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There was yet another research conducted by Procházka (2015) that has explained the
efforts that have been performed by IASC to harmonize the accounting standard setting but these
efforts have faced many barriers such as political influence, economic condition and other
cultural factors. The study conducted by this author has analyzed drivers that are responsible for
the conduct of political lobbying and how these drivers have changed the economic conditions of
specific group. Some of important drivers responsible for the political lobbying include
managerial compensation plan and debt structure. So it can be said that political lobbying occurs
mostly due to the change in accounting methods that decrease the economic benefits arising to
any specific entity and in turn decreases the executive compensation. Thus, entities make all
efforts to influence the political parties so that they take favor for them at group meeting of
IASB.
According to Eroglu (2017), lobbying is also industry specific and more likely to occur
when there is specific shift in accounting process of such industry. Lobbying takes place at
various level depending upon the impact that change in accounting standard will create on
specific group of industry, people or society. It means if any political party faces any major loss
due to the change in accounting than such political parties will surely make very efforts to
influence the decision of standard setter. The result of political lobbying will result in more
favorable accounting regulation and standard for the specific group of people.
Political lobbying examples with specific context to Australia, US and Global
level
 Impact of Australia political parties AASB 1015: In February 2000, two of the
opposition parties in Australia have passed the disallowance motion for the optional
treatment provided by the AASB through amending the AASB 1015. This accounting
standard deals with the reconstruction within the economic entities. This accounting
standard has been disregarded by the opposition parties and it has led to failure of new
accounting treatment under AASB 1015. It is done to provide the advantage to the
specific group of industries and to promote the political influence of dissenters over the
ruling party (Zeff, 2002).
 Lobbying performed during 1992-95 in United related to the stock options: During
the year 1992-95, there has been seen that industries in US have fiercely reacted to the
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exposure draft that requires the change in stock option plan of employees by estimating
them at fair value of the options granted and also to record the expenses occurs on
changing the method in current year itself. At this all the major industries opposes this
exposure draft through the comment letters and change the plan of FASB to amend the
accounting standard (Zeff, 2002).
Conclusion
It has been inferred from the above discussion held that accounting standard-setting by
the regulatory bodies such as IASB has been significantly influenced by the corporate failure and
the political context. The corporate failures have caused the improvements in the accounting
standards and regulations in order to improve the integrity in the financial reporting process. The
development of new accounting standard of IFRS 9 regarding the use of fair value measurement
approach during financial reporting have been developed to overcome the weakness of far value
accounting model used by the corporations during the period of financial crisis. Also, there have
been larger influence of political groups also to the accounting standard-setting process and this
is resulting in causing benefit to specific group of stakeholders rather than to the general public.
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References
Ahmad, A. (2015). Lobbying in Accounting Standards Setting. Global Journal of Management
and Business Research: Accounting and Auditing, 15(3), pp. 1-5.
Akpotu, C. (2013). External Auditors’ Unethical Behaviour and Corporate Business Failure in
Public Owned Organizations in Nigeria. International Journal of Business and
Management Invention 2(4), pp. 12-18.
Bengtsson, E. (2011). Repoliticalization of accounting standard setting—The IASB, the EU and
the global financial crisis. Critical Perspectives on Accounting 22, pp. 567-580.
Chatham, M., Larson, R. & Vietze, A. (2010). Issues affecting the development of an
international accounting standard on financial instruments. Advances In Accounting 26
(1), pp. 97-107.
Eroglu, Z.K. (2017). The Political Economy of International Standard Setting in Financial
Reporting: How the United States Led the Adoption of IFRS Across the World.
Northwestern Journal of International Law & Business 37(3), pp. 457-512.
Giroux, G. (2008). What Went Wrong? Accounting Fraud and Lessons from the Recent
Scandals. Social Research: An International Quarterly 74 (4), pp. 1205-1238.
Goelzer, D. (2019). Lessons from Enron: The Importance of Proper Accounting Oversight.
Retrieved 8 May, 2019, from
https://pcaobus.org/News/Speech/Pages/07262006_GoelzerTokyoAmericanCenter.aspx
Lemus, E. (2014). The Financial Collapse of the Enron Corporation and Its Impact in the United
States Capital Market. Global Journal of Management and Business Research:
Accounting and Auditing 14(4).
Li, Y. (2010). The case analysis of the scandal of Enron. International Journal of Business and
Management, 5 (10), 37-41.
Masoud, N. & Daas, A. (2014). Fair-Value Accounting’s Role in the Global Financial Crisis?:
Lessons for the Future. International Journal of Marketing Studies 6 (5), pp. 161-171.
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Procházka, D. (2015). Lobbying on the iasb standards: an analysis of the lobbyists’ behaviour
over period 2006–2014. Copernican Journal of Finance & Accounting 4(2), pp. 129-143.
Sherman, D. & Yound, D. (2016). Where Financial Reporting Still Falls Short. Harvard
Business Review.
Zeff, S.A. (2002). Political” Lobbying on Proposed Standards: A Challenge to the IASB.
Accounting Horizons 16(1), pp. 43-54.
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