Accounting can be summed up as the process of identifying, measuring, and communicating financial information about economic entities to interested parties.
There are two accounting processes:
Financial Accounting – This is the process that leads to the preparation of financial reports on an enterprise. These reports are used by both internal and external parties.
Managerial Accounting – This is the process of identifying, measuring, analyzing and communicating financial information needed by management to plan, control, and evaluate a company’s operations.
Example – determining how to assign overhead costs to production.
Financial statements are the principal means through which a company communicates its financial information to those in the outside.
The Financial information most frequently provided are:
1. The Balance Sheet
2. The Income Statement
3. Statement of Owner’s or Stockholders Equity
4. The Statement of Cash flows
Since we don’t have an unlimited supply of money, accountants must measure performance accurately, fairly, and on a timely basis to ensure that this scarce resource (money), is being put to the best use possible. It’s very important that this limited supply of money goes to enterprises that can use it to make more money. If this allocation of resources isn’t channeled effectively, everything comes to a screeching halt!
1. Parents lose money on their children’s college fund
2. Workers lose money on their retirement plans
3. States won’t generate enough tax revenue to help build or improve roads, schools, hospitals etc
4. The Federal government won’t be able to generate enough tax revenue to pay its bills.
So as you can see, accountants/bean counters play an important role in making sure limited resources are being channeled to the right enterprises. They play a critical role to ensuring a healthy economy. A health economy promotes productivity, encourages, people to think outside the box, encourages, people to buy and sell securities like stocks and bonds; and enable businesses borrowing and lending of money. What happens when accountants fail to measure performance accurately, fairly, and on a timely basis? Resources are channeled to the wrong enterprises, with dire consequences.
1. Enron - It resulted to the displacement of more than 20,000 people, the death of a “America’s Most Innovative Company” for six years in a row and the dissolution of one of the Big 5 global accounting firms (Arthur Andersen).
2. WorldCom - Inflated total assets through capitalization of operating costs. The amount? Estimated to be around $11 billion. WorldCom’s Chapter 11 bankruptcy filing is second only to the Lehman Brothers in 2008 in the history of such filings in the US.
3. Health South Corporation - The Company inflated its revenues by $1.4 billion. The inflation of revenues was worse in certain years, going as high as 4,700%. The reason? To meet the expectations of the company’s investors.
4. AIG - one of the foremost insurance company in the US and is one of the recipients of the bailouts from the US Government. The (accounting) scandal (among others) here involved the inflation of the company’s net worth by $2.7 billion.
5. Satyam Computer Services – a company based in India (now known as Mahindra Satyam). This is the most recent scandal (declared only in 2009) among those on this list. The accounting fraud in this case involves overstating cash ($1.5 billion) and receivables by $100 million and understating liabilities by $250 million. Taken together, Satyam’s assets were inflated by about $1.85 billion.