Regarding the implications derived, insufficient corporate governance, unsatisfactory quality of accounting and auditing professionals, impotent regulations in initial public offerings, faulty information disclosure requirements and inadequate protection of investors’ rights would be the emergent issues in China’s business world nowadays. Thus, four kinds of advices are proposed by author. Internally, the roles of supervisory board and independent directors should be stressed. Externally, the independence and moral of auditors should be emphasized. In addition, timely and reliable information disclosure by companies and investors’ lawsuit legalization should be developed.
2. Feedback
Undoubtedly, the aforementioned corporate accounting scandals are stemmed from the loopholes of legal and accounting systems, as well as the scarcity of intrinsic and extrinsic governances. Nevertheless, they still occur in the countries having more flawless accounting standard and governance.
The United States which has a long history in practicing the accounting standard should therefore have considerable experience in preventing accounting fabrications from occurring, but there are still accounting scandals and frauds in that country. In 2001, Enron was found that it deliberately inflated the profits of US$0.59 billion in total in three years by transferring the losses to the entities founded and controlled by it (i.e. related-parties). In 2002, Tyco was reported that the management embezzled company’s cash for private purpose. Also, WorldCom was found that it unjustifiably capitalized the expenses of US$3.85 billion to inflate the profits. Furthermore, Xerox was revealed that it overstated the operating revenues of US$6.4 billion in total in four years. But, such companies are audited by the auditing firms ranked as top five over the world including Andersen, KPMG and PricewaterhouseCoopers. Why do the accounting scandals still occur in The United States?
Perhaps, the factors affecting the occurrence of accounting frauds might be more than accounting standard and governance. In order to improve this issue, causes should be discovered first so that corresponding remedies can be implemented to adjust such causes. Therefore, a model is developed by reference to the components of audit risk (i.e. Audit Risk = Inherent Risk X Control Risk X Detection Risk) to categorize all factors into 4 sorts of components.
Firstly, we assume the accounting fabrication risk is the probability of undertaking accounting fabrications. Secondly, we define the inherent risk as the extent of management’s willingness to undertake the unjustifiable, immoral and illegal behaviors. That may vary largely depending on the management’s personality, education attainments and ethical standard, as well as the tone and culture of the company’s operating environment. The higher the willingness, the inherent risk is higher.
Thirdly, control risk which is defined as the risk of failing to prevent the accounting frauds from occurring by internal and external governances can be further subdivided into two components including internal control risk and external control risk. Internal control risk indicates the extent of effectiveness of the internal control system. The more effective the internal control system, the internal control risk is lower. On the other hand, the external control risk refers to the extent of effectiveness of the legal regulations and accounting standard, and the severity of governances by government agencies. The fewer the loopholes on the legal regulations and accounting standard, and the severer the governances, the external control risk would be lower.
Lastly, as management’s willingness to undertake accounting fabrications will be dropped if auditors are capable to detect such frauds, so the detection risk implies the risk of failing to lower the management’s willingness to undertake financial frauds by auditing. The lower the failure, the detection risk is lower. Generally speaking, the probability of occurrence of accounting fabrications mainly come from the extent of senior management’s willingness, but this can be moderated by the internal and external governances, and the quality of assurance works.
In order to mitigate the aggravation of corporate accounting frauds, measures which can lower the risk of any component in the equation (Table 2) would be advisable. Considering the inherent risk, the only way to diminish management’s interior willingness to commit accounting fabrications must be via education. So, emphasis of and instillation of professional ethics should be incorporated into the academic education as well as professional training.
In respect of the internal control risk, the issue of that a company is dominated by a few directors must be circumvented. Stricter regulations regarding the appointment and capability of independent directors should be laid down. Besides, establishment of “actually functional” auditing committee should be mandatory for all listed companies.
In contrast, regarding the external control risk, harmonization with international accounting standard should be further accelerated. Moreover, the effectiveness of governances by government agencies should be facilitated by closely monitoring both high-performing and low-performing firms since they are more likely to engage in illegal activities (Mishina, Dykes, Block & Pollock, 2010).
Finally, with regard to the detection risk, it completely relies on the professionalism of auditors. Even though they are all competent, their independence is still impaired by corruption from client companies. Therefore, continuous trainings in respect of the professional ethics should be provided. In addition, criminal punishments such as imprisonment should be adopted for penalizing auditors accepting corruptions.
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3. References
Ho, M. H. & Wong, S. K. Principles of Auditing and Management Information Systems. 2nd edition. Pearson Education South Asia Pte Ltd.
Mishina, Y., Dykes, B. J., Block, E. S., & Pollock, T. G. (2010). Why “good” firms do bad things: The effects of high aspirations, high expectations, and performance on the incidence of corporate illegality. Academy of Management Journal, 53, 701-722.
Wang, X. B. (1992). The effect of accounting scandals on profit management and quality. National Cheng Kung University.
Ewen. Relationship between accounting scandals and ethical education. [online] Available at: