Dr Norman Meonske Kent State University Dr Norman

Dr. Norman Meonske Kent State University Dr. Norman Meonske Ohio Council IMA January 30, 2003 Kent State University

Are We. Dead Yet?

Why so many financial statement frauds all of a sudden? Good economy was masking many problems Moral decay in society Executive incentives Wall Street expectations—rewards for short-term behavior

Why so many financial statement frauds all of a sudden? Nature of accounting rules • Behavior of CPA firms Greed by investment banks, commercial banks, and investors Bad Lawyer Advice?

Why so many financial statement frauds all of a sudden? Failure of Corporate Audit Committees Board of Directors Failures and Greed Financial Analyst Conflict of Interests and Greed • Education Failures Corporate Accounting Ability Regulation

Good economy was masking problems …. With increasing stock prices, profits and wealth for everyone, no one worried about potential problems.

Money Makes The World Go Round or Not Go Round

Greenspan Prints More Money

Don’t Take This Dollar !!!

Detailed Rules Detailed Complicated Rules With Loop Holes Big Enough To Drive A Truck Through

More Rules FASB

Nature of Accounting Rules Allows companies and auditors to be extremely creative when not specifically prohibited by standards. In the U. S. , accounting standards are “rules-based” instead of “principles based. ” It is impossible to makes rules for every situation

Examples are: SPEs and other types of off- balance sheet financing Revenue recognition approaches, Merger reserves Pension accounting Other accounting schemes.

When the client pushes, without specific rules in every situation, there is no room for the auditors to say, “You can’t do this…because it isn’t GAAP…”

DA FASB Example

GAAP CRITICISM Fosters Earning Game Does Not Show Value Creation

Executive Incentives • Meeting Wall Street’s Expectations • Performance is based on earnings & stock price –Focus is on short-term (quarterly) performance only –Stock prices are tied to meeting Wall Street’s earnings forecasts –Executives have been endowed with hundreds of millions of dollars worth of stock options—far exceeds salary-based compensation (tied to stock price) Companies are heavily punished for not meeting forecasts

Average compensation of America's top 100 CEOs has risen from 39 times that of the ordinary worker in 1970 to 1, 000 times in 1999. Princeton University

Stock Fell 13% With This Revelation Jack Welch, Former General Electric Chairman GE had not disclosed those perks -- which included courtside sports tickets, a Manhattan apartment, and use of a corporate jet -- beyond a vague statement in an SEC filing that Welch would have "continued lifetime access to company facilities and services. . . "

Beat The Numbers

How To Play Numbers Game Aggressive Accounting Earnings Management Income Smoothing Fraudulent Financial Reporting Creative Accounting Practices

Rewards of The Game Share Price Effect Borrowing Cost Effect Bonus Plan Effect Political Cost Effect

• How to value a dot. company: Take their loss for the year Multiply the result by negative 1 to make it positive Multiply that number by at least 100 If stock price is less than the result…Buy, If Not? Buy it anyway

Incentives for F. S. Fraud Incentives to commit financial statement fraud are very strong. Investors want decreased risk and high returns. Risk is reduced when variability of earnings is decreased. Rewards are increased when income continuously improves. Firm A Firm B Which firm will have the higher stock price?

Auditors—the CPAs • Failed to accept responsibility for fraud detection (SEC, Supreme Court, public expects them to detect fraud) If auditors aren’t the watchdogs, then who is? • Became greedy--$500, 000 per year per partner compensation wasn’t enough; saw everyone else getting rich • Audit became a loss leader –Easier to sell lucrative consulting services from the inside –Became largest consulting firms in the U. S. very quickly (Andersen Consulting grew to compete with Accenture • A few auditors got too close to their clients • Entire industry, especially Arthur Andersen, was • punished for actions of a few

In a separate case in late September, a judge's divorce ruling unsheathed guarded financial information about accounting firm Ernst & Young, which is a private partnership that does not file public financial reports. In divorce papers for Ernst & Young chief executive officer Richard S. Bobrow, a 45 -page judge's opinion revealed how much the CEO was paid and put a dollar value on the company for the first time, giving competitors a rare peek into the firm's finances.

Annual Salary $ 3 Million $25 million in salary $US 29 million in partnership earnings over the next decade. Pension worth $1 million a year for life and had access to a corporate jet owned by Ernst & Young and a New York apartment. $ 24 million to Janet Bobrow Jan Bobrow makes $ 10 an hour part-time at Central Church of the Nazarene in Lenexa, Kan.

Moral Decay • Attendees at the April, 1998 Business Week Forum of Chief Financial Officers revealed: – 67% of CFOs said they had been asked by senior company executives to misrepresent corporate financial results – 12% of CFOs admitted they had actually misrepresented financial results… 55% said they had fought off requests to “cook the books” • Honesty studies – 1961: 12% – 1986: 31% – 2002: ? ? ?

How Much Stanford MBA Worth? a. $500, 000 dollars b. $ 10 Million dollars c. $ 100 Million dollars d. $ 1 billion dollars

The market lopped a cool $1 billion off Veritas' (VRTS) market cap yesterday when its CFO resigned after revealing he lied about his academic credentials. The fundamental picture hasn't changed—unless the CFO's duplicity extended to the books.

Executives at Vetrias, storage management software maker, found that CEO’s claim to have earned an MBA from Stanford Business School was false.

Financial Statement Fraud Will Destroy Your Shareholder Value

Financial Statement Fraud • Financial statement fraud causes a decrease in market value of stock of approximately 500 to 1, 000 times the amount of the fraud. $7 million fraud $2 billion drop in stock value

These Are Interesting Times • Number and size of financial statement frauds are increasing • Number and size of frauds against organizations are increasing • Some recent frauds involve several people—as many as 20 or 30 (seems to indicate moral decay) • Many investors have lost confidence in credibility of financial statements and corporate reports • More interest in fraud than ever before—now a course on many college campuses—from 3 or 4 to over 50 college campuses

Current Executive Fraud. Related Problems • Misstating Financial Statements: Quest, Enron, Global Crossing, World. Com, etc. • Executive Loans and Corporate Looting: John Rigas (Adelphia), Dennis Kozlowski (Tyco--$170 million—the $15, 000 umbrella stand) IPO Favoritism: Bernie Ebbers ($11 million) • CEO Retirement Perks: Delta, Pepsi. Co, AOL Time Warner, Ford, GE, IBM (Consulting Contracts, Use of Corporate Planes, Executive Apartments with meals,

Current Executive Fraud-Related Problems • Exorbitant Stock Options for Executives

Complaint in Fraud Case • Several hundred million in earnings overstatement • Complaint: “The goal of this scheme was to ensure that (the company) always met Wall Street’s growing earnings expectations for the company. (The company’s) management knew that meeting or exceeding these estimates was a key factor for the stock price of all publicly traded companies and therefore set out to ensure that the company met Wall Street’s targets every quarter regardless of the company’s actual earnings. During the period ___ to ___alone, management improperly inflated the company’s operating income by more than $500 million before taxes, which represents more than one-third of the total operating income reported by (the company. )”

Complaint in Fraud Case • “The participants in the illegal scheme included virtually the entire senior management of (the company), including but not limited to its former chairman and chief executive officer, its former president, two former chief financial officers and various other senior accounting personnel. In total, there were over 20 individuals involved in the earnings overstatement schemes. ”

Fraud Internationally • • 1. Denmark 2. Finland 3. Sweden 4. New Zealand 5. Canada 6. Netherlands 7. Norway 8. Australia • • 13 Germany 14. United Kingdom 16. U. S. A. 36. Brazil 40. Philippines 47. Mexico 49. Russia 52. Nigeria

Largest Bankruptcy Filings (1980 to Present) Company Assets (Billions) When Filed 1. World. Com $101. 9 July, 2002 2. Enron $63. 4 Dec. , 2001 3. Texaco $35. 9 April, 1987 4. Financial Corp of America $33. 9 Sept. , 1988 5. Global Crossing $25. 5 Jan. , 2002 6. Adelphia $24. 4 June, 2002 7. PG&E $21. 5 April, 2001 8. MCorp $20. 2 March, 1989 9. Kmart $17. 0 Jan. , 2002 10. NTL $16. 8 May, 2002

Recent Financial Statement Frauds • Enron • World. Com • Adelphia • Global Crossing • Xerox • Qwest • Many others

THE BEGINNING Enron began as a pipeline company in Houston in 1985. It profited by promising to deliver so many cubic feet of gas to a particular utility or business on a particular day at a market price.

Deregulation of electrical power markets, a change due in part to lobbying from senior Enron officials: Chairman Kenneth L. Lay, expanded Enron into an energy broker, trading electricity and other commodities

RISING POWER Enron became a giant middleman that worked like a hybrid of traditional exchanges. But instead of simply bringing buyers and sellers together, Enron entered the contract with the seller and signed a contract with the buyer, making money on the difference between the selling price and the buying price. Enron kept its books closed, making it the only party that knew both prices.

Over time, Enron began to design increasingly varied and complex contracts. Contract to insure against: 1. a rise or fall in interest rates, 2. a change in the weather, or 3. a customer's inability to pay. 4. By the end, the volume of such financial contracts far outstripped the volume of contracts to actually deliver commodities

THE UNRAVELING As its services became more complex and its stock soared, Enron created a constellation of partnerships that allowed managers to shift debt off the books. • Chewco • Whitewing

Special Purpose Entities (SPEs) (Enron’s principal method of financial statement fraud involved the use of SPEs (Special Purpose Entities)) • Originally had a good business purpose • Help finance large international projects (e. g. gas pipeline in Central Asia) • Investors wanted risk and reward exposure limited to the pipeline, not overall risks and rewards of the associated company • Pipeline to be self-supported, independent entity with no fear company would take over • SPE limited by its charter to those permitted activities only • Really a joint venture between sponsoring company and a group of outside investors • Cash flows from the SPE operations are used to pay investors

Enron’s Use of Special Purpose Entities (SPEs) • To hide bad investments and poor-performing assets (Rhythms Net Connections). Declines in value of assets would not be recognized by Enron (Market to Market. ) • Earnings management—Blockbuster Video deal--$111 million gain (Bravehart, LJM 1 and Chewco) • Quick execution of related-party transactions at desired prices. (LJM 1 and LJM 2) • To report over $1 billion of false income • To hide debt (Borrowed money and not put on financial statements of Enron) • To manipulate cash flows, especially in 4 th quarters • Many SPE transactions were timed (or illegally backdated) just near end of quarters so that income could be booked just in time and in amounts needed, to meet investor expectations

Special Purpose Entities & Off-Balance Sheet Financing What is the business purpose? To transfer risks and losses to someone else One Enron Example (the “Rhythms” transaction): • Enron holds Internet stock in company called Rhythms Net. Connections • Stock is restricted (can’t be sold for a certain period of time • Enron doesn’t want exposure to risk of a price drop • The solution is simple! Find someone else who believes the Rhythms stock price will rise and is willing to sell a contract (a put option) to buy the stock in the future at a set price (a hedge!) • The problem is that Enron can’t find anyone willing to “do the deal” • Another simple solution! Start a company (a Special Purpose Entity or SPE) to take the other side of the transaction (Enron called it LJM 1) • Where does the financing come from? – 97% from bank loan Guaranteed with Enron stock – 3% from entity other than Enron Andrew Fastow and others! Now “Do the Deal” • Enron gives $168 million in Enron shares to LJM 1 (LJM 1’s primary asset) • LJM 1 gives Enron a note for $64 million and a put option valued at $104 million • When everything “settles out, ” Fastow receives $15 million for his $1 million investment • Enron gets to “hedge” (i. e. , not report) a $103 million market loss on its stock investment

LJM 1 SPE • Responsible for 20% of SPE restatement or $100 million • Should have been consolidated—an error in judgment by Andersen (per Andersen) • After Andersen’s initial review in 1999, Enron created a subsidiary within LJM 1, referred to as Swap Sub. As a result, the 3% rule for residual equity was no longer met. • Andersen was reviewing this transaction again at the time problems were made public —involved complex issues concerning the valuation of various assets and liabilities.

The Chewco SPE • Accounted for 80% of SPE restatement or $400 million—hid losses • In 1993, Enron and the California Public Employees Retirement System (Calpers) formed a 50/50 partnership— Joint Energy Development Investments Limited (JEDI) • In 1997, Enron bought out Calpers’ interest in JEDI • Chewco Financing – $240 million loan from Barclays, guaranteed by Enron – $132 million loan from JEDI – $11. 4 million loan from Barclays; called Equity – $0. 1 million from Enron employee • Financial reward to Enron employee – $2 million management fee over 3 years (remained fulltime Enron employee) – $10 million liquidation ($125 K investment)

LJM 2 SPE Raptors I-IV • Established by Enron CFO to provide a quick buyer for Enron assets • By December 2000, $1. 5 billion in “hedged” investments, $500 million Enron “gain” • Financial reward to Enron CFO—at least $15 million • Enron Financial Statement Impact—Hedged $1 billion in losses over 5 quarters; reported earnings of $1. 5 billion.

Insufficient Disclosure……. • 2000 Proxy Statement “During 2000, certain Enron subsidiaries…entered into a number of transactions with LJM 2 Co-Investment…Andrew S. Fastow, Executive Vice President and Chief Financial Officer of Enron, is the managing member of LJM 2’s general partner. ” • Paragraph outlining the transactions • “These transactions occurred in the ordinary course of Enron’s business and were negotiated on an arm’s length basis with senior officers of Enron other than Mr. Fastow. Management believes that the terms of the transactions were reasonable and no less favorable than the terms of similar arrangements with unrelated third parties. ”

Fastow’s Explanation of Partnerships (SPEs) • The partnerships were used for “unbundling and reassembling” the various components of a contract. “We strip out price risk, we strip out interest rate risk, ” he said. “What’s left may not be something that we want. ” • The obvious question is “Why would anyone want whatever was left? ”

Role of Andersen • Was paid $52 million in 2000, the majority of which was for non-audit related consulting services. Failed to spot many of Enron’s losses Kept a whole floor of auditors assigned at Enron year around • Enron was Andersen’s second largest client

• • Did both external and internal audits CFOs and controllers were former Andersen executives Accused of document destruction— was criminally indicted Went out of business One Partner “I had $4 million in my retirement account and lost it all. ” Some partners who transferred to other firms now have two equity loans and no retirement savings.

Where was Anderson? Enron’s Audit Committee Auditor (Arthur Andersen) Enron’s Executives Did they know? • 2/5/01: Andersen partners meet to discuss Enron’s accounting, related parties, fees, etc. • Issue: For a significant amount of time, according to notes of the meeting, the Andersen accountants debated a critical point: What should they do about two SPEs, LJM 1 and LJM 2, that had been set up 18 months earlier by Fastow? • Resolution: They drew up a "to do" list: – Recommend a special committee of the Board to review LJM deals. – Review the SPE accounting tests. • 2/12/01: The Big Meeting: Andersen partners meet with Enron board's audit and compliance committee. • All Enron executives were excused from the room. • And then………. . no evidence of any discussion • Interesting side note: From 1997 to 2001, Enron paid Andersen $5. 7 million in connection with work performed specifically on the LJM and Chewco transactions.

Anderson Shredding The Document Destruction Chronology • • October 12 – Nancy Temple sends “Document retention policy” email to Michael Odom. October 17 – SEC asks Enron for information about its accounting. October 23 – David Duncan calls urgent meeting, organizes effort to shred and dispose. The topics of discussion, according to a typed agenda, included: "SEC probe/shareholder lawsuits" and "soft and hard copy file review. " November 8 – Andersen receives subpoena from SEC. November 9 – Duncan’s assistant sends email to secretaries: “no more shredding. ” Email message about Document Policy: To: Michael C. Odom Date: 10/12/2001 10: 53 a. m. From: Nancy A. Temple Subject: Document retention policy Mike. It might be useful to consider reminding the engagement team of our documentation and retention policy. It will be helpful to make sure that we have complied with the policy. Let me know if you have any questions. Nancy

The Cost of “Bad Press”

Some partnerships' losses would have to be paid for out of Enron stock or cash in 2003, bringing the debts back home. There are indications that Enron executives and its accounting firm, Arthur Andersen, had warnings of problems nearly a year ago. According to a Feb. Andersen considered dropping Enron as a client. In August, Enron Vice President Sherron Watkins wrote an anonymous memo to former Chairman Kenneth L. Lay, detailing reasons she thought Enron "might implode in a wave of accounting scandals. "

On Oct. 16, Enron announced a $638 million loss for the third quarter, and Wall Street reduced the value of stockholders' equity by $1. 2 billion. Enron announced Nov. 8 that it had overstated earnings over the past four years by $586 million and that it was responsible for up to $3 billion various in obligations to partnerships. A $23 billion merger offer from rival Dynegy was dropped Nov. 28 after lenders downgraded Enron's debt to junk-bond status.

THE INVESTIGATION Dozens of lawsuits have been filed against the company by an array of pension funds. Dozens more are directed at former Chairman Kenneth L. Lay, former CEO Jeffrey Skilling and former Chief Financial Officer Andrew Fastow.

Kenneth L. Lay, former Enron Chairman and CEO (resigned Jan. 23, 2002) Lay and Enron poured millions of dollars into both political parties, cultivating access and using the entree to lobby Congress, the White House and regulatory agencies for action that was critical to the energy company's spectacular growth. In addition to being one of the single largest financial backers of President George W. Bush's political career, Lay is also one of the president's friends.

Greed

Andrew Fastow, former Enron Chief Financial Officer (ousted Oct. 24, 2001) Fastow was removed as Enron's CFO on Oct. 24, 2001 as the SEC began a probe into conflicts of interest in two partnerships he created and managed. Those partnerships earned him around $30 million in management fees from the deals in addition to his Enron salary.

In early October, Fastow was charged with securities, wire and mail fraud, money laundering and conspiring to inflate Enron's profit

Kopper and his domestic partner, William D. Dodson, reaped $10. 5 million based on a $125, 000 investment in a partnership called Chewco, according to an investigative report issued by Enron's board of directors. In August 2002, Kopper pleaded guilty to financial wrongdoing and agreed to surrender $12 million in the first criminal case against a company official.

Jeffrey Skilling, former Enron Chief Executive Officer (resigned Aug. 14, 2001) Senior Enron executives criticized former CEO Skilling about possible conflicts of interest in two partnerships he created with former Chief Financial Officer Andrew Fastow. Jeffrey Mc. Mahon, then Enron's treasurer, was "highly vexed" about the conflicts, "complained mightily" and suggested a list of remedies.

Clifford Baxter, former Enron Vice Chairman (resigned May 2, 2001) Baxter was one of 29 former and current Enron executives and board members named as defendants in a federal lawsuit, after he sold 577, 436 shares of Enron for $35. 2 million before Enron's collapse. He was found shot to death in a car Jan. 15, 2002, in an apparent suicide.

Watkins is the internal whistleblower who in August of 2001, more than two months before Enron disclosed it had overstated its profits and understated its debts, warned Kenneth L. Lay that the company might "implode in a wave of accounting scandals. " Shortly after Enron Chief Executive Officer Jeffrey Skilling suddenly resigned. Watkins described "a veil of secrecy" around partnerships involving the energy-trading company's former chief financial officer, Andrew Fastow

Arthur Andersen The job of Arthur Andersen, one of the nation's largest accounting firms, was to make sure investors could rely on Enron's financial statements. But Andersen also was a major business partner-soliciting and selling millions in consulting services to Enron. Andersen was also responsible for some of Enron's internal bookkeeping, and some Andersen executives ended up taking jobs at Enron.

Led by then-chief executive Joseph F. Berardino, Arthur Andersen took its case public, saying it would take "all appropriate steps" to defend its integrity. Berardino also suggested that the company might stop selling consulting services to firms it audits. Barardino has since resigned from the firm.

Employees Thousands of Enron employees, many with similar skills, were left unemployed. Enron encouraged employees to invest in the company, matched their 401(k) contributions with company stock, and briefly froze the plan in late October, barring employee sales, before the stock's final plunge. Thousands of employees and retirees have next to nothing in their accounts.

Banks One of Enron's biggest lenders, J. P. Morgan Chase, announced losses of $456 million as of Jan. 2002 related to Enron's demise. Citigroup recorded $228 million as of Jan. 2002 in Enron -related losses. But banks and regulators said the overall impact would be minimal, because no one bank is overinvested in Enron. THE IMPACT

Investors Enron's stock lost nearly all its value, dropping from almost $34 on Oct. 16, 2001. Billions of dollars in stock value were erased. The stock has been delisted from the New York Stock Exchange. THE IMPACT

Politicians Several prominent politicians from both parties returned Enron contribution money to the company or contributing it to charity. Others have been asked about their relationships with Enron. THE IMPACT

Arthur Andersen Its reputation was badly damaged. Divisions of the business have been sold to other companies. There is also the possibility of staggering liability claims. And Now there are 4 THE IMPACT

SEC files suit against KPMG and partners over Xerox Accounting

They have been charged with allowing Xerox to report false financial results between 1997 and results 2000, rather than risk losing a key audit client. Office equipment maker Xerox last June was forced to restate more than US 6 Billion in revenues over 5 years after regulators accused it of using accounting tricks to prop up its earnings. tricks

Response Specifically, KPMG offered a detailed description of events as they unfolded in the Xerox case and argued that it did the "right thing" by refusing to sign off on the company's 2000 financial statements in the face of what it called "strong client resistance. "

• FBI Agent Coleen Rowley, who called the bureau on the carpet for ignoring evidence hinting at the September 11 terrorist attacks. Former Enron vice president Sherron Watkins, whose memos warning company chairman Ken Lay about accounting irregularities failed to stop Enron's collapse. Cynthia Cooper, a World. Com vice president who told the company's board of directors about nearly $4 billion in accounting irregularities.

$10 Billion Expenses Treated As Assets

John Rigas (former CEO) The founder and former head of Adelphia, and two of his sons have been charged with looting the nation's No. 6 cable company to pay for luxury condos, a golf course and to cover personal investment losses.

Sam Waksal (former CEO) The former CEO of Im. Clone was arrested earlier this month on charges of insider trading for allegedly trying to sell his company's stock and tipping off family members after learning of the impending FDA decision on its new cancer drug Erbitux.

Martha Stewart A close friend of Sam Waksal, has repeatedly denied any wrongdoing in selling nearly 4, 000 Im. Clone shares on Dec. 27, a day before federal regulators said they would not consider the drugmaker's application for its new cancer drug. Im. Clone's shares plummeted after the news came out.

Boo Hoo I Lost $400 Million

Dennis Kozlowski (former CEO) Pleads innocent to charges of evidence tampering after earlier pleading the same to charges of evading taxes on purchases of valuable paintings.

--Dennis Kozlowski, the CEO until he was indicted and resigned in June, borrowed more than $40 million from the company, and the loans were later forgiven, reports the Wall Street Journal. The SEC rules governing disclosure of CEO pay are quite clear on those matters, and there is simply no way to avoid disclosing the forgiveness of such loans. Yet Tyco never did. The company neither confirms nor denies any of this, declining to comment pending the completion of an internal investigation.

Sample Frauds • Large Fraud of $2. 6 Billion over 9 years – – – Year 1 Year 3 Year 5 Year 7 Year 9 $600 K $4 million $80 million $600 million $2. 6 billion • In years 8 and 9, four of the world’s largest banks were involved and lost over $500 million Some of the organizations involved: Merrill Lynch, Chase, J. P. Morgan, Union Bank of Switzerland, Credit Lynnaise, Sumitomo, and others.

Why Fraud is a Costly Business Problem that must be addressed by corporate executives • Fraud Losses Reduce Net Income $ for $ • If Profit Margin is 10%, Revenues Must Increase by 10 times Losses to Recover Affect on Net Income – Losses……. $1 Million – Revenue…. $1 Billion • Fraud Robs Income Revenues $100 100% Expenses 90 90% Net Income $ 10 10% Fraud 1 Remaining $ 9 To restore income to $10, need $10 more dollars of revenue to generate $1 more dollar of income.

Fraud Cost…Two Examples • General Motors – $436 Million Fraud – Profit Margin = 10% – $4. 36 Billion in Revenues Needed – At $20, 000 per Car, 218, 000 Cars • Bank – $100 Million Fraud – Profit Margin = 10 % – $1 Billion in Revenues Needed – At $100 per year per Checking Account, 10 Million New Accounts

Educators • Haven’t taught “ethics” enough (can’t make up own rules to meet own needs” • Need to teach students about fraud—need a “fraud” course Need to teach students how to think • Need to teach students how to think –We have taught them how to copy, not think We have asked them to memorize, not think

Educators – We have done what is easiest for us and easiest for our students

Accounting Education and Learning Theory • Behaviorist Approach – Learners are seen as empty vessels that instructors pour knowledge into –Professors use primarily lecture-based teaching –Students are provided with information needed to produce the desired behavior—high scores on content-based examinations. Professors assign homework problems similar to examples used in class, examples in textbooks, and problems on examinations.

Accounting Education and Learning Theory – Students use text or lecture notes as guides and solutions manuals. –Students need not define the problem or understand why something is done the way it is or what other alternatives are available —only how something is done.

Problems with Accounting Education 1. Teach outdated stuff—replaced by technology —teach to the past, not the future 2. Too narrow and specialized 3. 150 -hour programs—more of the same 4. Ph. D. programs reinforce specialization 5. Don’t cover important topics in the right ways a. Globalization b. Technology c. Various business models

Problems with Accounting Education 1. Rule-based, memorization, test-for-content, prepare for certification model, doesn’t add significant value 2. Does not expose students to ambiguity enough 3. Lacks creativity a. Not enough teaching of skills b. Not enough out-of-classroom activities c. Not enough focus on technology Technology has changed everything

What are we teaching our students? • One of the main things we are teaching is “how to copy. ” – Not from a solutions manual or from other students (because that is prohibited), but from examples in the chapter or from other students. • Students are not developing higher-level thinking skills or learning to identify issues or define unstructured problems. • When they graduate and find themselves performing an audit or completing a tax return, they do what we taught them to do--they reference what was done last year (a similar example) and copy (with different numbers and slight changes in format) • They don’t think analytically about what has changed or even what is going on • They don’t consider what the risks and substance of transactions are, or what changes in the numbers mean. • They are copying because we taught them how to copy

Educational Focus • Why do educators spend so much time focusing on content when content memorization has such a short useful life and when skills are transferable across positions and last so much longer? • Is it because this type of teaching is easier to teach and much easier to assess?

Using Constructivist Teaching • Critical in the new environment—to help our students think analytically • Can no longer use textbook (or CDs) to drive everything we do • Best class is combination of reading (text), video, cases, experiential learning (field studies, service-learning, etc. ), group work, etc. • Let’s look at why this is important—the Enron example

Some Thoughts • Doing what’s easiest—our “train monkey” or “operant conditioning” approach to teaching has led to: –Inhibiting their ability to assess risks and think analytically –Rule-based standards that allow firms to basically do whatever they want—you can’t legislate everything –An ethical and public relations nightmare for accountants and the accounting profession

Types of Fraud • Fraudulent Financial Statements • Employee Fraud • Vendor Fraud • Customer Fraud • Investment Scams • Bankruptcy Frauds • Miscellaneous Frauds • The common element is deceit!

What’s Hot in Accounting--7 Sizzling Areas • • Assurance services--Elder care Consulting services Environmental accounting Forensic accounting Information technology services International accounting Tax and financial planning

Corporate Accountability Sarbanes Bill

Whistleblower Protection Prohibits Disciplining or Discriminating against employees who provide information regarding securities law violations

Attorney Professional Conduct Requires Attorney’s to Report Material Violations of Securities or Breaches of Fiduciary Duty to the Company’s CEO or Chief Legal Officer or if necessary to the Board of Directors

New and Increased Felonies + Civil Action Destruction of of Documents Longer Periods For Civil Fraud Increased Criminal Penalties Lower Thresholds To Bar for Unfitness No Bankruptcy Discharge of Securities Law Liability

Auditor Independence & Rotation of Audit/Review Partners every 5 years Prohibits Some Non Audit Services

8 K Disclosures Expanded 8 K Disclosures Accelerated 8 K Reporting – 2 Days

Accounting Issues New Issuer Fees SEC Adopt Principles-based Accounting System Unlawful to Fraudulently Influence Auditors New Rules for Financial Experts on Audit Committee New Management Assessment of Internal Control

Non-US Companies Not Exempt New CEO/CFO Apply To Foreign Private Issuers

NYSE and NASDAQ Have Made Proposals For the SEC To Consider NASDAQ NYSE

Enhanced Disclosures Material Off-Balance Sheet Transactions Reconciliation of Pro Form F/S SEC Review – 3 Years “Real Time” Disclosures of Material Changes To Financial Condition Expenses

Accelerated Due Dates For Periodic Reports MD&A Disclosures of Critical Accounting Policies Detailed Quantitative & Qualitative Matters – No Boilerplate

Management Transactions Loans 8 K Security Transactions Including Preplanned Purchase/Sale

The SEC Sets New Ground Rules on Selective Disclosure & Insider Trading

CEO/CFO Certification and Disclosure Process

Corporate Code of Ethics

Enhanced Audit Committee Forfeiture of Bonuses, and Stock Incentives For Majority of Restatements Due Directors Must Be Independent to Misconduct

Dynamic Duo

Once The Camel Stick Its Head In the Tent, We Will Have Problems

The Sarbanes-Oxley Act apparently did not go far enough to suit California lawmakers. Under a law that took effect this month, public companies based in California or doing business there have to give the state extra layers of detail on insider activity.

Key Elements of Public Trust Spirit of Transparency Culture of Accountability People of Integrity