Accounting and Bookkeeping

D

5

Steps Five and Six

Once the adjustments are calculated and entered in the ledger, the accountant prepares an adjusted trial balance—one that combines the original trial balance with the effects of the adjustments (step five). With the balances in all the accounts thus updated, financial statements are then prepared (step six). The balances in the accounts are the data that make up the organization's financial statements.

D

6

Step Seven

The final step is to close noncumulative accounts. This procedure involves a series of bookkeeping debits and credits to transfer sums from income-statement accounts into owners' equity accounts. Such transfers reduce to zero the balances of noncumulative accounts so that these accounts can receive new debit and credit amounts that relate to the activity of the next business period.

V

Regulations and Standards

Until 1973 a committee of certified public accountants (CPAs) established accounting principles in the United States. CPAs are accountants licensed by their state government on the basis of educational background, a rigorous certification examination, and in most jurisdictions, relevant practical work experience. In 1973 the seven-member Financial Accounting Standards Board was created as an independent standard-setting organization. Regulations for auditors are promulgated by the American Institute of Certified Public Accountants. United States companies whose stocks or bonds are traded publicly must conform to rules set by the Securities and Exchange Commission (SEC), a federal government agency. Tax laws and regulations are administered at the federal level by the Internal Revenue Service (IRS) and at the local level by state and municipal government agencies. Many countries other than the United States also have systems of accounting standards. The International Accounting Standards Board, based in London, England, exists to achieve international harmonization of accounting principles.

The United States has no standard-setting body for managerial accounting. From 1971 to 1980, however, the federal Cost Accounting Standards Board established accounting rules that apply to contracts entered into by parties that sell goods and services to the federal government. The nongovernmental Institute of Management Accounting administers a certification program, qualifying candidates for a certificate in management accounting (CMA). The Institute of Internal Auditors has a program enabling an accountant to be designated a certified internal auditor (CIA).

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A

Accounting Reforms

At the beginning of the 21st century, the accounting profession in the United States was rocked by a series of scandals. In 2001 the Enron Corporation, a major energy-trading company, acknowledged that its financial statements for nearly five previous years were erroneous because the company had failed to follow generally accepted accounting practices. Instead of the massive profits it had reported, the company revealed that it had actually lost $586 million from 1997 through 2001. The U.S. Department of Justice indicted the CPA firm of Arthur Andersen LLP, Enron’s outside auditor and one of the largest accounting firms in the world. In 2002 a jury convicted Andersen of obstructing justice by shredding documents sought by the SEC.

The Enron scandal was followed in 2002 by another infamous case of accounting fraud involving another prominent corporation known as WorldCom, Inc., a major telecommunications company. The company admitted that it had failed to report more than $7 billion in expenses over five quarterly periods and had actually lost $1.2 billion during that period, although its financial reports indicated that it had been profitable. The vast sums of money involved made it the largest accounting fraud ever. As the year progressed, other major U.S. companies and their accounting firms came under SEC investigation.

The U.S. Congress responded to these accounting scandals by passing legislation that imposed the strictest government oversight of the accounting profession since the 1930s. The new law, known as the Public Company Accounting Reform and Investor Protection Act of 2002, created the Public Company Accounting Oversight Board, a five-member board under the supervision of the SEC. The law gave the board the authority to investigate and penalize accounting firms that audit the financial statements of publicly traded companies in a substandard manner. The board was required to set accounting rules and standards with the SEC’s approval and to perform annual audits of any accounting firm that supervises the financial reports of more than 100 public companies. The latter provision was regarded as one of the most important because the accounting profession had been self-policing until the board was created.

Under the law, all accounting firms that audit publicly traded companies must register with the federal government. The oversight board has the power to suspend accounting firms and individual CPAs found guilty of violations and may impose substantial fines against both individual accountants and a CPA firm. The board may also refer cases to the Justice Department for criminal prosecution. Observers said the law’s strongest sanction was the ability to suspend accountants who have committed violations from working for publicly traded companies.

The SEC selects the chairperson and the other four members of the oversight board. To insulate the board from influence by the accounting profession, only two members may be CPAs, and the chairperson cannot have been a practicing CPA for at least five years prior to the appointment. All board members must work exclusively for the board, and their terms are staggered over five-year periods.

Other reform measures under the new law required that chief executive officers (CEOs) and chief financial officers (CFOs) of publicly traded companies of a designated size sign statements affirming the accuracy of their firm’s financial reports. Any CEOs or CFOs who “willfully and knowingly” permit misleading information in those reports could face prison terms. The law also prohibited accounting firms from offering many consulting services to clients contemporaneously with a mandated audit. The purpose of this provision was to prevent conflicts of interest. During the Enron scandal, it was revealed that Andersen earned greater amounts of money from providing consulting services to Enron than it obtained from performing auditing services. Some critics asserted that this created an incentive for Andersen to ignore auditing problems.

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