The reporting of financial information is of great essentiality to both the organization and the other stakeholders. “Accounting information is reliable to the extent that it is verifiable, is a faithful representation of the underlying economic reality, and is reasonably free of error and bias” (Young et al, 2007, p. 38). It is therefore a requirement that companies publish their financial statement at the end of every trading period.
The society requires this information to be up to date and in accordance with the financial regulation boards and accounting standards such as the GAAP and GAAS among others. Companies that fail to follow the laid down rules and in turn misquote figures of the financial statements end up being forced to restate the financial statements.
Once such a thing occurs, the reputation of the company is greatly affected as well as all stakeholders. This paper is therefore an in0depth analysis of the possible causes of wrong financial reporting and the impacts it comes with as well as a discussion of the remedies and solutions that can be adopted by the company to overcome the issue.
Accounting theory is a broad term that can be simply defined as a “set of basic concepts and assumptions and related principles that explain and guide the accountant’s action in identifying, measuring, and communicating economic information” (Young et al, 2007, p. 123).
It therefore guides the accountant in preparing and giving accounting information by providing a logical framework to be used in the accounting practice. His is because it is basically based on the rules, principles and assumptions to be applied in accounting. From the accounting theory, companies become in a position to be consistent and in-line with the stipulated accounting standards.
Based on the accounting theory, companies are therefore placed in a position in which they can chose low cost contracts that minimize the contracting costs. His is referred to as positive accounting theory or rather (PAT). The positive accounting theory assumes that managers will be rational just like investors hence making the securities market to be efficient.
About Nortel Networks Corporation
Nortel Networks Corporation or simply known as Nortel is a leading manufacturer of telecommunications equipment based in Toronto, Canada. With time, Nortel has expanded to reach other parts of the world especially in the United States hence becoming a multinational company. In addition to this, Nortel has its operations divided into four main segments which include;
- Carrier Networks
- Global Services
- Metro Ethernet Solutions
- Enterprise Solutions
The Unethical Acts of Nortel Company
Most operating organizations have been faced with the problem of making ethical decisions with regard to their operations. This has been caused by the increasing number of stakeholders as well as the huge responsibilities that have been bestowed to the accountants. As a result, there have been many public financial and accounting scandals in the recent past.
Consequently, authorities have therefore been put in place to punish and warn the companies that practice any fraudulent activities. A case in study is that of Nortel Company which in the early 2000s practiced fraudulent activities by not following accounting regulations. The following are some of the company’s accusations;
First of all, it was reported that the company executives through fraudulent accounting methods, they gave a false report about the company. Through the use of fraudulent accounting acts, they were able to bridge the gap between the company’s real performance and the public expectations as well as its internal goals. As a result, the company’s shareholders and investors regardless of their size incurred huge losses after relying on the wrongly published information about the company.
This scandal involved four senior executives of the company who were accused of disregarding accounting standards and requirements of disclosure to provide the wrong picture about the company. One of the executives by the name MR. Dunn, the financial officer was responsible for restating the company’s financial results all the way from 2000 to 20003. The company overstated costs in 2001 and 2002 and then understated them in 2003. This was very absurd as the reported information proved to be unreliable.
In addition to the above complains, it was also noted that three of the executives by the name Dunn, Pahapill and Beatty” altered Nortel’s revenue recognition policies to accelerate revenue as needed to meet forecasts and, from at least July 2002 through June 2003, Dunn, Beatty and Gollogly improperly established, maintained and released reserves to meet earnings targets, fabricate profits and pay performance-related bonuses” (SEC, 2007, p. 1).
To achieve this wrong information to the public, the executives of the company breached the revenue recognition policies to alter the revenue numbers hence showing wrong figures of reserves and earnings. In the end the figures given had been fabricated to indicate better performances in terms of profits and payouts. By doing this, the executives of the company were violating the accounting theory on earnings management whereby they selected wrong accounting policies so that they could achieve the specific earnings to report.
In this case they applied the bad earnings management instead of the good earnings management. Research has shown that bad earnings management has a negative impact on the financial reporting perspective of a company hence affecting all stakeholders of the company just like the case of Nortel company.
Last but not least are the findings of the auditors where they found out that the company’s financial statements had five material deficiencies.
Analysis of the problem
The case of Nortel Company is a perfect example of companies that have breached the laid down accounting standards. As for the case of Nortel, an analysis of the problem shows that the executives violated and ignored the protocols of GAAP that have been established by the United States.
According to the GAAP standards, companies listed in the public exchange are required to follow the stipulated accounting guidelines especially at all times even when publishing accounting information. Nortel’s executives breached to publish revenue information that met the expectations of the public yet it was not the right data.
Those who relied on the given data especially the shareholders and investors ended up making wrong decisions which in turn led to huge losses incurred. As a matter of fact, the information given only favored the executive members of the company but at the expense of the shareholders and investors.
This can be related to the accounting theory on opportunistic version of Positive Accounting Theory whereby the managers of a company benefit at the expense of the investors. The efficiency version of the positive accounting theory can also be linked to the case of Nortel Company as the mangers chose to apply the accounting policies that would maximize the contract efficiency hence giving the wrong picture about the company.
In a nut shell, the misdeeds of Nortel can be categorized into two groups with the first group being that of revenue recognition issues as from the year 2000. To be specific on this, the company applied the bill and hold transactions in order to increase revenues.
This was contrary to the accounting standards which require that inventory is first delivered to the customer before revenues are recognized. The second misdeed entailed the reserves or liabilities whereby the company reported higher income than it had attained. The executives did this by reducing the current debts instead of recognizing them as expenses. This they did when they desired greater income, for instance more bonuses allocated to them.
As stated above, the breaching of accounting standards to give false information regarding the company led to huge losses being incurred. Therefore the charges placed against the executive members of the company led to “permanent injunction, civil monetary penalties, officer and director bars, and disgorgement with prejudgment interest against all four defendants” (SEC, 2007, p. 1).
All the accused executives were heavily fined and forced to pay disgorgement, and interest to the tune of $143,481 to $163,031 each. The punishment given to the executive members of the company with regard to the case served as a warning to other company executives who would indulge into breaching of standards to deceive the public and stakeholders.
Given the false financial statements that the executives published, the company was forced to restate its statements. This is something that landed Nortel in the book of records as it had many restatements within a short period of time when compared to any other public trading company. It was even joked that it changed its financial statements more often than some people would change their hairstyles.
Solutions and Remedies
As stipulated by law, any entity that is publicly owned and operated is required to publish its financial statements at the end of each and very trading period. However, the information to be made public is used by all the company’s stakeholders starting from the managers, employees, shareholders, investors and creditors just to mention but a few.
Since wrong information could lead to huge losses and other negative impacts as seen in Nortel’s case, it is important that the information given gives a true and clear picture of the company. Therefore, in order to protect the public from such cases, the following should be done and implemented
- Publicly listed companies should ensure that they conduct frequent internal as well as external audits. This will ensure that the end result of the financial statements is the right one reflecting the true picture and financial position of the company. This will also ensure that any instances of fraud are detected early enough before they reach the public.
- Secondly, the companies should ensure that the financial officers strictly follow the accounting standards in their operations. This can be initiated by first checking the compliance of the financial officers with the accounting standards as well as their registration and membership with accounting regulation boards.
- The company should also ensure that any personnel that breach the accounting standards and policies are severely punished so as to deter them from repeating the crime while refrain others from committing it.
When the entire above are effectively managed, the public will be protected from fraudulent acts of the company executives hence being able to make correct decisions from the up to date information of the company.
As for the case of Nortel Company, the remedy was to fire the existing executives at the time of the financial scandal. After which, Nortel acquired a new set of executives who revived the company that was slowly going down to closure. Despite the fact that the shareholders’ confidence had been previously shuttered, the company has fully regained with many shareholders and investors.
From the above discussion on the case study of Nortel Company, the importance of adherence to the accounting standards is clearly seen. Especially for the public entities who are obliged to publish their financial information at the end of each trading period, breach of accounting standards is unethical and illegal hence punishable by law.
This is depicted when the executives of Nortel and especially the financial officer decide to violate the GAAP regulations and publish wrong financial statements to give a false financial position of the company. When the case is taken to the court the executives are severely punished for causing huge losses to the investors and shareholders. This not only serves as a warning to other companies but it also revives the company from the bad public image it had created.
As part of their punishment and follow up, the company is forced to restate its statements several times until the right image is portrayed. All the same, the problem regarding the misdeeds of Nortel Company is not as a result of auditors overlook or wrong report but it is the violation or breach of accounting standards that causes the financial scandals of the Company.
Since that time of the accounting fraud scandal and thereafter the punishment of the accused executives, the company has progressed well with lesser scandals to affect its operations.
It can thus be concluded that the problem of financial scandals in companies concerns the accounting regulation boards and the entire public. This is because if the public ignores the problem of accounting scandals, it will re-motivate some of today’s managers to use accounting for their own purposes. “It is thus important to keep in mind the schemes and their proper resolutions so as to avoid the loss of billions of dollars in wealth because of the accounting antics of yesteryear”(SEC, 2007, p. 1).
Young, N., Warfield, T. Weygandt, J., Wiecek, I, & Kieso, D. (2007). Intermediate accounting (8th ed.). Ontario, Canada: Wiley & Sons Ltd.